UNIVERSITY  OF  CALIFORNIA 
AT   LOS  ANGELES 


GIFT  OF 

MRS.    GEORGE   II.     U  M  CES 


29 


Library 

Graduate  Sch~ol  of  Business  Administration 

Uni  -^rsity  of  California 

Los  Angeles  24,  California 


NET  WORTH  AND  THE 
BALANCE  SHEET 


Net  Worth  and  the 
Balance  Sheet 

By 
HERBERT  G.  STOCKWELL,  C.P.A. 


New  York 

The  Ronald  Press  Company 
1912 


Copyright,  1911 

By 
THE  RONALD  PRESS  CO. 


Bus.  Admin. 
Library 


EXPLANATION  OF  THE  BOOK 

C  HREWD  business  men  take  pains  to  learn 

enough  about  the  accounts  on  their  books 

;*      to  know  where  they  stand  at  any  time  and 

*       whether  the  business  is  going  forward  or 

backward,  and  why. 

To  such  men  the  knowledge  of  the  vital 
facts  of  the  business,  as  shown  in  their  books, 
provides  means  by  which  complete  mastery 
of  the  business  may  be  obtained. 

But  these  shrewd  men  are  few  in  number 
compared  with  the  many  who  do  not  take 
^    the  trouble  to  solve  the  meaning  of  the  ac- 
•     counts  in  which  the  history  of  the  business 
N^    is  being  recorded. 

Such  men,  finding  the  study  of  facts  ex- 
|    pressed  in   figures  unattractive,  too   often 
R    leave  the  matter  of  bookkeeping  entirely  to 
j>J:heir  clerks,  easily  yielding  to  the  difficulty 
of  obtaining  the  correct  interpretation  of 
their  accounts. 

5 


6      Net  Worth  and  the  Balance  Sheet 

In  many  other  cases  the  proprietors,  with 
little  or  no  bookkeeping  knowledge,  yet 
dimly  seeing  the  advantages  to  be  gained  by 
greater  knowledge,  continually  struggle  in 
unavailing  efforts  to  comprehend  the  figures 
presented  to  them  by  their  bookkeepers. 

Whether  the  failure  to  grasp  the  impor- 
tant facts  of  a  business  results  from  insuffi- 
cient attempts  on  the  part  of  the  proprietor 
or  follows  earnest  efforts,  ignorance  of  the 
true  financial  conditions  has  been  the  cause 
of  many  bankruptcies  which  might  have  been 
avoided  had  impending  danger  been  known 
in  time. 

If  there  is  one  business  law  of  more  im- 
portance than  any  other,  it  surely  rests  in 
the  common-sense  principle  that  a  business 
man  should  know  at  all  times  where  his  busi- 
ness stands  in  relation  to  his  creditors,  and 
to  his  partners  or  shareholders.  Within 
reasonable  approximation  he  should  know  his 
"net  worth." 

In  order  fully  to  comprehend  all  that  is 
involved  in  his  net  worth,  he  must  acquire 
at  least  sufficient  knowledge  of  the  expres- 


Explanation  of  the  Book  7 

sion  of  business  facts  in  figures  to  enable 
him  to  read  and  understand  the  meaning  of 
his  balance  sheet,  or  statement  of  assets  and 
liabilities. 

In  obtaining  this  knowledge  he  will  find 
that,  as  his  stock  of  accounting  information 
increases,  along  with  each  new  comprehen- 
sion will  come  a  growing  strength  and  ability 
to  grasp  each  business  condition  as  it  arises. 
Besides  the  additional  control  over  his  own 
business,  obtained  in  the  study  of  his  ac- 
counts, he  will  gain  the  power  of  analyzing 
the  balance  sheets  of  other  concerns  in  whose 
financial  condition  he  may,  for  one  or  more 
of  many  reasons,  be  interested. 

Few  indeed  are  the  concerns  engaged  in 
banking,  manufacturing,  or  trading  to  whom 
credit  for  money  or  merchandise  is  not 
granted,  or  who  do  not  grant  credit  to  others 
upon  signed  statements  or  mercantile  reports. 
Moreover,  the  investor  in  the  bonds  or 
stocks  of  corporations  would  be  less  depen- 
dent upon  quotations,  rumors,  or  advice  of 
friends  if  he  could  himself  understand  the 
balance  sheets  of  the  corporations  whose 


8      Net  Worth  and  the  Balance  Sheet 

stocks  and  bonds  are  offered  to  him  for  in- 
vestment. 

Thus  it  appears  that  all  men  of  indepen- 
dent means  as  well  as  those  in  business 
would  find  advantages  in  the  possession  of  a 
moderate  amount  of  bookkeeping  knowledge, 
sufficient,  at  least,  to  enable  them  to  under- 
stand the  accounts  representing  assets  and 
liabilities  on  a  balance  sheet,  and  the  net 
worth  produced  by  the  proper  assembling  of 
those  accounts. 

The  present  work  is  intended  to  be  of  as- 
sistance to  all  those  whose  duty  or  interest 
compels  either  the  preparation  or  inspection 
of  balance  sheets  of  merchants  or  manu- 
facturers. It  endeavors  to  explain  the  na- 
ture of  the  items  involved,  to  point  out  what 
the  balance  sheet  does  or  should  show;  and 
to  furnish  such  information  as  will  enable 
those  seeking  further  knowledge  of  the  con- 
dition of  any  concern  than  is  shown  by  its 
balance  sheet  to  frame  intelligent  inquiries 
of  the  management,  tending  to  bring  out  the 
information  desired. 

The  present  volume,  as  intimated,  is  con- 


Explanation  of  the  Book  9 

fined  almost  entirely  to  the  ordinary  balance 
sheet  of  the  merchant  and  manufacturer.  To 
interpret  the  business  conditions  shown  by 
the  balance  sheets  of  steam  and  electric  rail- 
road corporations,  electric  light  and  power 
corporations,  water  and  gas  companies,  and, 
last  but  not  by  any  means  least,  national, 
state,  and  municipal  governments,  would  re- 
quire much  more  elaboration  than  can  be 
brought  within  the  limits  of  the  present  work. 
The  wide  and  interesting  field  of  accounting 
methods  involved  when  business  and  finan- 
cial facts  of  these  balance  sheets  are  ex- 
pressed in  figures,  will  well  repay  investiga- 
tion and  may  be  the  subject  of  a  second 
volume. 

The  definitions  appearing  in  italics  have 
been  framed  in  an  effort  to  simplify  some  of 
the  terms  commonly  used  by  business  men, 
bookkeepers,  and  accountants. 

H.  G.  S. 


CONTENTS 

CHAPTER  PAGE 

I.  Net  Worth 13 

II.  Balance  Sheets 17 

III.  Cash 23 

IV.  Notes  Receivable 31 

V.  Notes  Receivable  (continued)    .     .  39 

VI.  Accounts  Receivable 48 

VII.  Accounts  Receivable  (continued)     .  56 

VIII.  Merchandise 62 

IX.  Finished  Product 72 

X.  Partly  Finished  Product  ....  78 

XL  Raw  Materials  and  Supplies  ...  83 

XII.  Real  Estate 87 

XIII.  Machinery — Fixtures 9l 

XIV.  Furniture  and  Fixtures    ....  96 
XV.  Other  Assets 98 

XVI.  Other  Assets  (continued)     .     .     .107 

XVII.  Notes  Payable 116 

XVIII.  Accounts  Payable 120 

XIX.  Deposits 124 

XX.  Bonded  Debt 127 

XXI.  Mortgages 130 

11 


12  Contents 

CHAPTER  PAGE 

XXII.  Other  Liabilities 134 

XXIII.  Capital  and  Capital  Stock  .      .     .      .138 

XXIV.  Surplus— Profits 147 

XXV.  Reserves 157 

XXVI.  Reserves    (continued)       .    .  .      .      .163 
XXVII.  Contingent  Liabilities       .      .      .      .172 
XXVIII.  Analysis  of  Balance  Sheet     .      .     .178 
XXIX.  Comparison   of    Successive   Balance 

Sheets  ,   182 


Net  Worth  and  the  Balance 
Sheet 

CHAPTER   I 
NET  WORTH 

jpHE  net  worth  of  any  business  enterprise 
consists  of  the  excess  of  the  amount  of 
its  assets  over  its  liabilities. 

For  example: 

Total  Assets $500,000.00 

Total   Liabilities 250,000.00 

Net  Worth $250,000.00 

In  a  statement  of  assets  and  liabilities  the 
resulting  balance  is  called  net  worth  on  the 
theory  that  if  all  of  the  assets  of  the  business 
were  sold  for  cash,  and  all  of  the  debts  were 
paid  out  of  that  cash,  the  amount  remaining 
would  constitute  the  real  capital  of  the  own- 
ers of  the  liquidated  business. 

13 


14     Net  Worth  and  the  Balance  Sheet 

In  other  words,  while  a  business  man  owns 
numerous  assets  in  various  forms,  many  of 
those  assets  may,  and  generally  do,  consist 
of  articles  of  commerce  which  he  has  pur- 
chased, but  for  which  at  the  time  the  state- 
ment is  prepared  he  has  not  yet  paid.  There- 
fore, in  order  to  ascertain  how  much  of  the 
cash  and  other  assets  in  various  forms  really 
belong  to  him,  he  prepares  a  statement  show- 
ing all  assets  in  his  possession  and  all  lia- 
bilities for  unpaid  obligations.  The  balance, 
produced  by  subtracting  the  sum  total  of  all 
of  the  liabilities  from  the  assets,  represents 
what  he  may  call  the  amount  of  his  own 
wealth  or  worth. 

Since  all  assets  constitute  wealth,  or  worth, 
we  might,  from  one  point  of  view,  say  that  a 
man  is  worth  as  much  as  the  total  value  of  all 
of  the  lawfully  acquired  assets  in  his  pos- 
session, and  this  without  regard  to  his  lia- 
bility to  pay  for  such  portion  of  those  assets 
as  were  purchased  on  credit. 

But  this  aspect  of  wealth  or  worth  does 
not  take  into  consideration  the  business 
man's  relation  to  those  from  whom  he  has 


Net  Worth  15 

purchased  or  borrowed  wealth,  so  in  business 
statements  we  do  not  rest  satisfied  with  in- 
formation concerning  the  gross  wealth  or 
worth.  We  deduct  from  the  amount  thereof 
the  total  of  his  debts  and  thus  ascertain  his 
net  worth. 

This  process  is  referred  to  as  producing 
theoretical  results,  because  as  a  matter  of 
practice  no  business  is,  or  can  be,  liquidated 
and  wound  up  with  a  resulting  cash  balance 
in  hand  exactly  equalling  the  amount  of  the 
net  worth  shown  in  a  balance  sheet  prepared 
prior  thereto. 

Valuation  of  Assets 

With  even  the  greatest  amount  of  care  and 
expert  appraisement  of  assets,  it  is  impos- 
sible to  fix  absolutely  in  advance  of  an  actual 
sale  the  cash  value  of  such  assets  as  mer- 
chandise, machinery,  or  buildings.  Until  the 
exchange  of  such  assets  for  cash  has  actually 
taken  place,  all  calculations  of  value  are  but 
expressions  of  opinion,  more  or  less  accurate, 
according  to  the  ability  of  the  appraiser  and 
his  experience  with  what  has  happened  in  the 


16    Net  Worth  and  the  Balance  Sheet 

past,  on  which  he  bases  his  judgment  as  to 
future  happenings. 

It  will  thus  be  seen  how  important  it  is 
that  very  careful  estimates  be  made  of  all 
assets  in  the  balance  sheet.  Unless  the  esti- 
mates are  approximately  correct,  being 
neither  very  much  too  high  nor  too  low,  the 
business  man  may  be  deceived  as  to  his  real 
financial  position. 

Moreover,  a  record  of  his  progress  and  in- 
crease in  business  is  clearly  indicated  by  the 
increase  in  the  amount  of  the  net  worth 
shown  on  his  balance  sheet  at  the  end  of  any 
given  period,  as  compared  with  the  amount 
shown  on  a  similar  statement  prepared  at 
the  beginning  of  that  period,  due  considera- 
tion being  given  to  cash  withdrawn  from  the 
business  between  closing  periods  in  the  form 
of  profits.  Thus  the  calculations  of  values 
become  the  more  important  to  the  extent  that 
errors  in  under-  or  over-estimating  his  assets 
at  the  beginning  or  ending  of  a  given  period 
may  create  notions  of  his  prosperity  or  pov- 
erty not  existing  in  fact. 


CHAPTER   II 
BALANCE  SHEETS 

V\7"HILE  a  balance  sheet  of  a  merchant  or 
manufacturer  should  represent  his 
true  financial  condition,  some  of  the  accounts 
contained  in  the  ledger  from  which  the  bal- 
ance sheet  has  been  prepared  may  undergo 
considerable  change  and  adjustment  before 
the  assets  represented  by  the  accounts  are 
transformed  into  cash  or  its  equivalent. 

A  clear  example  is  furnished  in  the  aggre- 
gate of  customers'  debit  balances,  ordinarily 
styled  "Accounts  Receivable."  Some  of 
these  debit  balances  may  have  been  created 
by  charges  for  merchandise  ordered,  shipped, 
and  billed  in  the  regular  course  of  business, 
and  yet  the  goods  may  not  be  accepted  at 
billed  value.  Claims  for  errors  or  for  dam- 
aged or  under-graded  goods  may  be  set  up 
before  the  account  has  been  rendered  to  and 
accepted  by  the  customer.  Furthermore,  the 
customer  may  fail  to  settle  the  account. 

17 


18    Net  Worth  and  the  Balance  Sheet 

For  these  and  other  reasons,  it  is  clear 
that  such  accounts  do  not  represent  assets 
in  the  same  way  as  do  accounts  representing 
the  merchandise  itself  before  it  is  sold.  Un- 
less sold  for  actual  cash,  the  merchandise 
asset  is  first  exchanged  for  a  claim  against 
the  purchaser,  to  be  again  converted  into  a 
cash  asset,  when  he  finally  pays  for  the  mer- 
chandise. 

If  we  keep  fixed  in  our  minds  the  fact  that 
some  ledger  accounts  represent  claims  in 
various  stages  of  liquidation,  as  well  as 
actual  assets,  it  should  be  possible  to  so  dis- 
tinguish these  that  an  understanding  of  the 
various  items  in  a  balance  sheet  will  present 
fewer  difficulties. 

Form  of  Balance  Sheet 

The  following  is  an  ordinary  form  of  bal- 
ance sheet,  such  as  is  recommended  by  the 
American  Bankers'  Association  to  its  mem- 
bers for  use  in  obtaining  statements  of  the 
financial  condition  of  those  applying  for 
loans  at  their  banks. 

In  this  statement  form  the  assets  and  lia- 


Balance  Sheets  19 

bilities  are  shown  in  two  columns — the  assets 
in  the  column  to  the  left  and  the  liabilities 
in  the  column  to  the  right — the  total  of  the 
items  in  the  asset  column  and  in  the  liability 
column  being  equal  each  to  the  other.  This 
form  is  used  largely  by  bookkeepers  and  ac- 
countants in  preparing  written  balance  sheets 
on  regular  ledger  paper.  It  frequently  hap- 
pens, however,  that  when  the  balance  sheet  is 
to  be  shown  on  the  printed  page  there  is 
not  sufficient  room  for  this  form,  and  what 
is  known  as  the  report  form  is  adopted.  In 
this  the  assets  appear  in  one  group  or  set 
of  figures,  over  the  second  grouping  or  set  of 
figures  which  represent  the  liabilities.  This, 
of  course,  is  a  mere  matter  of  form ;  the  par- 
ticular way  in  which  a  balance  sheet  is  stated 
being  immaterial  so  long  as  all  of  the  facts 
are  truthfully  represented. 

Among  English  accountants  it  is  the  prac- 
tice to  reverse  the  form  usually  found  in  this 
country,  the  liabilities  appearing  in  the  col- 
umn to  the  left  and  the  assets  in  the  column 
to  the  right.  This  arrangement  is  based 
upon  the  idea  that  the  management  charges 


20    Net  Worth  and  the  Balance  Sheet 

itself  with  all  of  its  liabilities  and  credits 
itself  with  its  assets,  while  in  this  country 
the  balance  sheet  is  thought  of  as  a  list  of 
debit  and  credit  balances  just  as  they  are 
found  on  the  ledger,  and  as  the  debit  balances 
are  shown  on  the  ledger  in  a  column  to  the 
left,  and  the  credit  balances  in  a  column  to 
the  right,  the  same  order  is  preserved  in  the 
preparation  of  the  balance  sheet. 

SCARBOROUGH  MANU 

Balance  Sheet, 
Assets 

Cash $26,843 .90 

Bills  Receivable  (net) 7,752.84 

Accounts  Receivable  (net).  111,172.08 

Merchandise 224,323.82 

Land   50,000 .  oo 

Buildings   189,934.93 

Machinery — Fixtures 134,266.25 

Reserve  Fund  Investments.  22,626.79 

Other  Investments 17,428.72 

Miscellaneous  ...     $900.00 
120.85 

1,020.85 


Total  Assets $785,370. 18 


Balance  Sheets  21 

In  order  that  the  balance  sheet  recom- 
mended by  the  American  Bankers'  Associa- 
tion may  be  used  by  many  different  classes 
of  concerns,  it  is  necessarily  very  general  and 
condensed.  Only  such  accounts  appear  as 
constitute  the  main  or  chief  accounts  of  the 
average  concern,  although  many  other  ac- 
counts with  different  names  may  also  be 
found  on  its  books.  The  filled-in  figures  are 

FACTORING  COMPANY 

December  31,  1911 

Liabilities 

Notes  Payable $70,000.00 

Accounts  Payable 15,312.92 

Deposits   3,026.67 

Bonded   Debt 100,000.00 

Mortgages    5,000.00 

Accrued   Liabilities 1,177.09 


Total  Liabilities...  $194,516.68 

Capital    400,000 .  oo 

Surplus — Profits 82,436. 50 

Reserves 108,417.00 


Total $785,370.18 


22    Net  Worth  and  the  Balance  Sheet 

taken  from  a  typical  case,  the  name  at  the 
head  of  the  balance  sheet,  of  course,  being 
fictitious.  In  the  blank  official  form  the 
names  of  the  accounts  are  printed  down  the 
asset  side  to  and  including  "Machinery  and 
Fixtures."  Below  that  are  several  blank 
lines  in  which  for  the  purposes  of  the  pres- 
ent consideration  the  accounts  "Reserve 
Fund,"  etc.,  have  been  inserted.  The  liability 
side  is  given  here  as  printed  in  the  official 
form. 

The  statement  as  presented  is  in  the  form 
of  a  corporate  balance  sheet.  The  few  differ- 
ences between  a  statement  of  the  net  worth 
of  a  partnership  and  that  of  a  corporation 
will  be  explained  in  later  chapters. 

In  the  chapters  which  follow,  each  item 
shown  on  the  statement  of  the  Scarborough 
Manufacturing  Company  is  taken  up  in 
order,  and  the  nature  of  the  debits  and  cred- 
its which  produce  the  balances  set  out  against 
the  named  accounts  is  considered. 


CHAPTER   III 

CASH 

TV/T OST  of  us  are  fairly  well  informed  as 
to  the  paper  currency  and  the  gold, 
silver,  and  copper  coins  received  and  paid  in 
the  ordinary  course  of  small  tradings.  The 
balance  of  cash  in  one's  pockets  is  the  result, 
so  far  as  the  handling  of  actual  cash  is  con- 
cerned, of  all  one's  previous  cash  transac- 
tions. Many  of  our  personal  instalments  of 
income  are  received  in  the  form  of  checks 
and  coupons,  as  well  as  actual  cash.  The  sur- 
plus over  and  above  the  amount  needed  for 
pocket  expenditures  is  deposited  in  a  bank- 
ing institution  of  some  kind. 

So  it  is  with  a  business  concern.  The  cash 
balance,  as  shown  on  the  Cash  Book,  is  the 
difference  between  the  receipts  from  all 
sources  on  the  one,  or  debit,  side  of  the  book 
and  the  payments  on  the  other,  or  credit,  side. 
The  balance  between  the  receipts  and  pay- 
ments is  the  exact  amount  by  which  the  re- 

23 


24    Net  Worth  and  the  Balance  Sheet 

ceipts  have  exceeded  the  payments,  and  cash 
should  be  found  in  the  possession  of  the  con- 
cern to  an  amount  equal  thereto. 

As  a  rule,  a  business  man  keeps  little  actual 
currency  and  coin  in  his  office  or  store.  Checks, 
money  orders,  and  every  other  form  of  bank- 
able funds  received  during  the  course  of  the 
business  day,  and  all  actual  cash,  excepting 
such  as  is  needed  for  current  expenses,  are 
deposited  in  his  bank. 

In  the  example  given,  the  cash  of  the 
Scarborough  Manufacturing  Company  was 
divided  as  follows : 

Cash  in  Bank  (deposits) $23,098.73 

Cash  on  Hand  (petty  cash  fund) ....  500.00 

Cash  in  Hands  of  Branch  Managers        3,245.17 


Total $26,843.90 

Cash  in  Bank 

Cash  in  Bank  means  undrawn  deposits  in 
solvent  banks,  trust  companies,  with  bankers, 
or  in  other  depositories,  payable  by  check 
upon  demand. 

It  is  difficult  to  frame  a  concise  definition 
completely  describing  this  asset.  It  would 


Cash  25 

appear  unnecessary  to  insist  that  the  amount 
said  to  be  in  bank  must  consist  of  the  amount 
deposited,  less  all  checks  issued  against  it. 
With  few  exceptions,  business  men,  book- 
keepers, and  cashiers  understand  and  adhere 
to  this  principle,  but  in  some  few  cases  busi- 
ness men,  in  order  to  present  favorable  state- 
ments, affect  to  think  that  the  actual  amount 
standing  to  their  credit  on  the  books  of  the 
bank  is  the  amount  which  they  may  consider 
as  in  bank,  disregarding  those  checks  which 
have  been  drawn  and  issued  and  sent  to  such 
distant  points  that  in  the  ordinary  course  of 
events  several  days  must  intervene  before 
they  can  return  and  be  presented  to  the  bank. 
In  one  recent  case  of  bankruptcy  the  treas- 
urer of  the  corporation  concerned  had  habit- 
ually drawn  and  issued  checks  to  an  amount 
greater  than  the  balance  to  the  credit  of  the 
company  in  his  bank,  depending  upon  his 
ability  to  collect  funds  and  deposit  them  be- 
fore the  outstanding  checks  could  be  pre- 
sented to  the  bank  for  payment.  In  other 
words,  his  bank  account,  according  to  his 
own  check  book,  was  continuously  over- 


26    Net  Worth  and  the  Balance  Sheet 

drawn,  while  on  the  bank's  books  the  com- 
pany apparently  always  had  a  balance  to  its 
credit.  At  least,  it  always  had  such  an  ap- 
parent balance  until  one  day  the  treasurer 
was  unable  to  provide  the  funds  necessary 
to  meet  the  incoming  checks,  and  a  bank- 
ruptcy was  brought  on  which  might  have 
been  avoided  by  stricter  accounting  and  more 
businesslike  methods. 

It  is  much  safer,  and  more  honest,  for  a 
business  man  to  consider  that  his  bank  bal- 
ance has  immediately  been  reduced  by  the 
amount  of  the  checks  issued,  regardless  of 
the  time  which  may  elapse  before  the  checks 
are  actually  presented  at  his  bank  and  de- 
ducted from  his  credit  balance. 

"Cash  in  Bank"  usually  includes  deposits 
payable  upon  check  or  "order  only  after  prior 
notice"  of  such  intention,  according  to  con- 
ditions under  which  the  deposits  were  made, 
but  if  the  amount  is  large  and  not  available 
upon  reasonably  short  notice,  it  would  be 
better  to  set  out  the  amount  of  such  funds 
separately  from  the  current  checking  ac- 
counts. 


Cash  27 

For  instance,  a  manufacturer  may  have 
$100,000  cash  balance  on  which  he  is  draw- 
ing no  interest ;  he  may  find  that  $50,000  is 
all  that  he  needs  for  current  working  capital. 
In  such  case  he  may  have  the  remaining 
$50,000  transferred  temporarily  to  another 
account  in  the  bank  on  which  interest  may 
be  paid  to  him,  and  the  amount  of  this  deposit 
be  shown  in  a  demand  or  time  certificate  of 
deposit.  As  a  general  rule,  certificates  of 
deposit,  whether  demand  or  time,  are  payable 
on  demand.  The  time  element  merely  defines 
the  period  during  which  the  money  must  be 
left  in  order  to  draw  interest.  There  may, 
of  course,  be  other  deposits  the  withdrawal 
of  which  must  be  preceded  by  notice,  as,  for 
example,  in  savings  banks,  where  with- 
drawals may  be  made  only  upon  order  with 
a  previous  notice  of  such  intention  declared 
a  week,  two  weeks,  or  thirty  days  in  advance. 

Frequently  checks,  drafts,  and  other  nego- 
tiable instruments  payable  at  distant  places 
are  received  by  the  banks  as  deposits  and 
credited  at  once  to  depositors,  if  in  good 
standing  with  the  bank,  it  being  understood 


28     Net  Worth  and  the  Balance  Sheet 

that  these  depositors  will  not  draw  against 
the  uncollected  credits.  Strict  banking  prac- 
tice calls  for  the  withholding  of  credits  for 
such  instruments  until  collection  is  effected. 
In  a  financial  statement,  if  the  amount  of 
such  uncollected  instruments  is  large,  it 
should  not  be  included  in  "Cash  in  Bank," 
but  should  be  described  as  "Checks,  Drafts, 
etc.,  for  Collection,"  and  entered  on  the  state- 
ment as  a  separate  item. 

Cash  on  Hand 

Cash  on  Hand  means  ready  money  in 
drawer  or  safe,  in  office  or  store,  in  branches 
or  agencies;  currency,  coin,  legal  tender,  or 
bank  notes;  also  checks  cashable  on  demand, 
money  orders,  or  other  instruments  received 
as  money,  which  in  the  ordinary  course  of 
business  will  be  received  by  the  bank  as  a 
cash  deposit. 

It  does  not  include  promises  to  pay  money 
in  the  future,  due  bills,  past  due  checks  or 
checks  dated  ahead,  promissory  notes  or 
memoranda  of  money  loaned  or  advanced 
for  any  purpose.  Such  items,  if  of  value, 


Cash  29 

should  be  stated  under  "Other  Assets,"  and 
listed  separately,  if  important:  but  if  insig- 
nificant, included  under  the  heading  "Mis- 
cellaneous." 

Actual  cash  in  the  possession  of  branch 
offices  or  stores  may  be  included,  but  un- 
settled accounts  of  cash  in  the  hands  of 
agents  or  representatives  to  be  accounted  for 
when  expended  should  not  be  included  as 
"Cash  on  Hand." 

Petty  Cash  and  Imprest  Fund 

Ordinarily  in  a  manufacturing  business 
very  little  actual  cash  is  required.  Such  as  is 
needed  for  petty  expenses  which  cannot  con- 
veniently be  settled  by  checks  is  provided  for 
by  means  of  the  Petty  Cash  fund  kept  in  a 
desk  drawer  or  safe. 

Some  concerns  are  accustomed  to  withhold 
from  the  deposits  of  the  day,  for  petty  cash 
purposes,  a  part  or  the  whole  of  the  currency 
and  coin  received — a  practice  not  to  be  com- 
mended— while  other  concerns  deposit  in 
bank  all  cash  in  whatever  form  it  is  received. 

Those  who  deposit  every  penny  of  cash  in 


30    Net  Worth  and  the  Balance  Sheet 

bank  provide  for  petty  cash  needs  by  means 
of  checks  drawn  on  their  bank  accounts,  and 
cashed.  In  such  cases  it  is  quite  a  common 
practice  to  charge  on  the  ledger,  through  the 
cash  book,  the  cash  from  the  first  check 
to  Petty  Cash  account  under  a  system  known 
as  an  Imprest  Fund,  where  the  amount  re- 
mains as  a  fixed  fund.  The  amount  of  this 
fund  is  maintained  thereafter  by  means  of 
subsequent  checks  to  equal  the  total  of  the 
depletions  of  the  fund  for  expenses;  the 
amounts  expended  being  periodically  charged 
to  the  proper  accounts  through  the  cash  book. 
At  any  given  time  the  amount  on  the  ledger 
will  be  represented  by  actual  cash  and  petty 
cash  vouchers. 


CHAPTER   IV 
NOTES  RECEIVABLE 

'HE  term  "Notes  Receivable"  means  ne- 
gotiable  promissory  notes  or  accepted 
drafts  received  from  customers  in  settlement 
for  goods  sold,  not  discounted,  transferred  or 
assigned. 

Many  people  use  the  term  "Bills  Receiv- 
able," meaning  the  same  thing  as  "Notes  Re- 
ceivable," but  as  some  of  these  confuse 
"Bills" — meaning  promissory  notes  received 
— with  bills  for  merchandise  purchased,  the 
distinction  is  better  preserved  in  the  use  of 
"Notes  Receivable." 

When  a  merchant  or  manufacturer  sells 
goods  to  his  customers,  as  a  rule  he  expects 
to  be  paid  within  a  certain  time,  fixed  accord- 
ing to  the  terms  of  the  particular  sales  or  the 
general  custom  prevailing  in  his  line  of 
business. 

Sometimes  promissory  notes  are  offered  by 
the  customer,  either  before  or  after  payment 

31 


32     Net  Worth  and  the  Balance  Sheet 

is  due  by  him  for  the  goods  purchased.  If 
the  promissory  notes  are  accepted  by  the  mer- 
chant or  manufacturer  the  amount  of  these 
notes  is  usually  credited  to  the  customer  in 
his  ledger  account  and  at  the  same  time  the 
"Notes  Receivable"  account  is  charged. 

Discounting  Notes  Receivable 

If  the  concern  receiving  such  notes  is  pro- 
vided at  the  time  with  sufficient  working 
capital,  it  will  retain  these  notes  in  its  safe 
until  shortly  before  they  become  due,  when 
they  are  sent  for  presentation  and  collection 
to  the  place  where,  by  their  terms,  they  are 
made  payable.  In  case  it  becomes  convenient 
to  obtain  funds  before  the  maturity  of  the 
notes,  they  are  sent  to  the  bank  for  discount ; 
the  bank  discounting  the  notes  by  deducting 
from  their  face  the  amount  of  interest  from 
the  day  of  discount  until  the  date  set  as  the 
time  for  payment  by  the  maker. 

The  notes  thus  disposed  of  are  credited  to 
the  Notes  Receivable  account,  the  amount  of 
the  discount  is  charged  to  Interest  and  Dis- 
count account,  and  the  difference  between 


Notes  Receivable  33 

the  interest  deducted  by  the  bank  and  the 
whole  amount  of  the  notes,  called  the  "pro- 
ceeds," is  charged  to  Cash. 

There  are  other  methods  by  which  the  dis- 
counting of  notes  is  placed  on  the  books,  but 
this  one  answers  the  purpose  of  showing 
that,  under  the  ordinary  procedure,  the  bal- 
ance of  the  Notes  Receivable  account  always 
shows  the  amount  of  the  notes  on  hand. 

Notes  received  and  subsequently  dis- 
counted at  bank  should  not  be  stated  as  an 
asset.  The  amount  of  such  discounted  notes 
remaining  unpaid  by  the  maker  at  the  time 
the  statement  is  prepared  should  be  stated  as 
a  contingent  liability  in  a  footnote  to  the 
balance  sheet. 

In  some  methods  of  bookkeeping  the  notes 
which  have  been  discounted  are  not  credited 
to  the  Notes  Receivable  account  according  to 
the  method  already  described,  until  actually 
paid  by  the  makers.  The  general  rule  that 
such  notes  should  not  be  stated  as  an  asset 
must  then  be  varied.  It  is  correct  as  to  prin- 
ciple, but  under  the  method  of  accounting 
just  referred  to  does  not  apply,  as  such  notes 


34     Net  Worth  and  the  Balance  Sheet 

are  carried  as  assets  with  an  offsetting  lia- 
bility. 

When  a  promissory  note  is  received  from 
a  customer  the  usual  practice,  as  stated,  calls 
for  a  debit  to  Notes  Receivable  and  a  credit 
to  the  customer  of  a  like  amount.  Then 
when  the  note  is  discounted  at  bank,  it  calls 
for  a  credit  to  Notes  Receivable  of  the  full 
amount  of  the  note  and  a  debit  to  Cash  of  the 
proceeds  received  from  the  bank,  and  another 
debit  to  Interest  and  Discount  of  the  amount 
of  interest  deducted  from  the  face  of  the 
note  by  the  bank. 

For  example : 

Method  A: 

Cash,  Dr $940.00 

Interest  and  Discount,  Dr. . .       60.00 
Notes  Receivable,  Cr $1,000.00 

Under  the  other  method  referred  to,  the 
course  is  similar  until  the  note  is  discounted, 
when  another  account  is  opened  called  "Notes 
Receivable  Discounted"  and  the  discounted 
note  is  credited  to  that  account  instead  of  to 
the  Notes  Receivable  account. 


Notes  Receivable  35 

For  example : 

Method  B : 

Cash,  Dr $940.00 

Interest  and  Discount,  Dr. . .       60.00 
Notes  Receivable  Discounted,  Cr.  .$1,000.00 

Assuming  that  the  Scarborough  Manufac- 
turing Company,  whose  Notes  Receivable  on 
the  balance  sheet  amounted  to  $7,752.84,  had 
received  other  notes  to  the  amount  of  $20,000 
not  then  due,  but  which  it  had  discounted  at 
bank,  under  method  B  the  balance  sheet 
would  show  as  follows : 

Under  Assets : 

Notes  Receivable $27,752.84 

Under  Liabilities: 

Notes  Receivable  Discounted 20,000.00 

This  condition  would  be  just  as  intelligible 
to  the  man  who  understands  this  method  as 
the  other  method  in  which  the  amount  of  con- 
tingent liabilities  is  stated  as  a  footnote  on 
the  balance  sheet. 

Following  the  process  a  little  further, 
when  the  maturity  date  of  the  note  dis- 
counted arrives,  and  the  note  is  found  to  have 


36    Net  Worth  and  the  Balance  Sheet 

been  paid  by  the  customer,  a  journal  entry 
is  made  as  follows: 

Notes  Receivable  Discounted. .  .$1,000 
To  Notes  Receivable $1,000 

The  object  of  this  method  is  to  have  the 
ledger  show  at  any  given  time  the  amount 
of  customers'  notes  which  have  been  dis- 
counted, but  which  have  not  yet  been  paid 
by  the  makers. 

The  only  objection  to  be  urged  against  this 
method  is  found  in  the  fact  that  it  places  on 
the  ledger  a  liability  that  is  not,  strictly 
speaking,  the  kind  of  liability  that  should  ap- 
pear there.  This  liability  is  that  of  the  in- 
dorser  of  a  note,  and  when  such  a  note  has 
been  received  for  goods  purchased  by  the 
maker  of  the  note,  the  indorser  is  not  liable 
unless  the  maker  fails  to  pay  it  himself.  It 
is  a  contingency  which  arises  every  time  a 
note  is  discounted  by  the  indorser  to  the 
extent  that  he  may  be  compelled  to  pay  back 
to  the  bank  the  money  advanced  by  the  bank 
on  the  note. 

In  a  well-managed  business,  where  the 
general  business  standing  of  the  customers 


Notes  Receivable  37 

is  good,  and  their  financial  responsibility  is 
established,  it  is  but  seldom  that  the  merchant 
or  manufacturer  is  compelled  to  pay  the 
notes  he  has  discounted,  and,  except  in  un- 
usual cases,  it  is  not  necessary  to  maintain 
the  Notes  Receivable  Discounted  account,  or 
to  make  the  extra  double  entry  in  the  books 
called  for  by  this  method. 

"Good"  Notes 

Notes  described  as  "good"  should  include 
only  such  negotiable  instruments  as  are  not 
due  when  the  statement  is  prepared  and 
which  the  merchant  or  manufacturer  actually 
believes,  after  diligent  inquiry,  will  be  paid 
by  the  maker  at  maturity.  Overdue  notes 
should  be  stated  in  a  separate  amount  under 
the  description  "overdue  notes." 

It  is  sometimes  very  hard  to  look  upon  the 
real  value  of  notes  in  hand  as  being  less  than 
the  face  value.  But  in  order  that  the  state- 
ment of  net  worth  may  not  contain  any  un- 
certain elements  it  is  necessary  to  scrutinize 
this  class  of  assets  with  care.  We  very  often 
hear  the  expression  regarding;  promissory 


288458 


38    Net  Worth  and  the  Balance  Sheet 

notes,  "They  are  as  good  as  wheat,"  when  a 
further  inquiry  reveals  some  doubt  of  the 
ability  of  the  maker  to  settle  his  obligations 
promptly.  Unless  fully  secured  either  by  col- 
lateral or  indorsement,  or  unless  warranted 
by  absolute  knowledge  of  the  financial  re- 
sponsibility of  the  makers  or  indorsers, 
Notes  Receivable  should  not  be  appraised  as 
"good"  for  the  full  amount. 

This  applies  especially  to  "Notes  Receiv- 
able" continuously  renewed  by  the  customers. 
Such  notes  should  not  be  stated  at  face 
value  unless  amply  secured  by  collateral  or 
by  indorsements.  It  is  easy  to  see  that  if 
a  debtor  does  not  reduce  the  amount  of  his 
indebtedness  within  a  reasonable  time,  he  is 
not  making  good  progress,  and  unless  some 
turn  in  his  affairs  should  improve  his  con- 
dition, his  ability  to  meet  his  obligations  may 
fade  away. 


CHAPTER   V 
NOTES  RECEIVABLE  (continued) 

T/f/^RITTEN  contracts  or   engagements 
not  negotiable,  to  pay  money,  or  for 
services  or  property,  should  not  be  included 
in  Notes  Receivable. 

Nothing  should  be  called  Notes  Receivable 
save  legal  negotiable  promissory  notes  given 
to  the  merchant  or  manufacturer  who  is  pre- 
paring the  statement.  All  other  contracts, 
rights,  patents,  processes,  and  evidences  of 
property  of  more  or  less  value  to  the  concern, 
should  be  shown  in  the  statement,  but  not 
under  Notes  Receivable. 

Accommodation  Notes 

Notes  Receivable  given  to  the  merchant  or 
manufacturer  for  his  accommodation  should 
be  stated  separately  and  not  as  a  part  of  the 
total  of  Notes  Receivable-from  customers  for 
goods  sold. 

Such  notes  are  the  same  in  effect  as  if 

39 


made  by  the  party  accommodated  and  in- 
dorsed by  the  party  issuing  the  paper,  it 
being  expected  that  the  merchant  or  manu- 
facturer for  whose  accommodation  the  note 
has  been  made  will  pay  it  at  maturity  regard- 
less of  his  nominal  position  on  the  paper. 

Any  notes  received  in  settlement  or  part 
settlement  of  previous  charges  on  open  ac- 
count should  be  deducted  from  such  accounts 
and  stated  as  Notes  Receivable.  This  is  be- 
cause the  acceptance  of  the  note  changes  the 
legal  form  of  the  claim  against  the  customer 
from  that  of  goods  sold  to  that  of  note  un- 
paid. 

Some  bookkeepers  charge  back  to  the  cus- 
tomer's account  a  note  received  from  him 
but  not  paid  at  maturity.  For  the  same 
reason  that  a  note  is  deducted  from  the  open 
account,  it  should  not  be  charged  back  when 
not  paid.  The  mere  failure  in  payment  does 
not  again  transform  the  note  into  a  claim  for 
goods  sold. 

Sometimes  when  accounts  due  for  mer- 
chandise sold  are  difficult  to  collect,  promis- 
sory notes  are  accepted  in  lieu  of  the  old 


Notes  Receivable  41 

account.  This  further  extends  the  time  of 
payment,  and  in  such  cases  the  promissory 
notes  may  not  be  worth  face  value  as  an 
asset. 

Notes  Not  in  the  Ordinary  Course  of  Business 

Notes  received  from  officers,  directors, 
partners,  clerks,  or  stockholders  should  not 
be  included  in  Notes  Receivable,  but  should 
be  stated  in  a  separate  amount. 

Sometimes  loans  are  made  to  those  directly 
connected  with  the  business,  and  memoranda, 
due  bills,  or  promissory  notes  are  taken  as 
evidence  of  the  loans,  which  are  then  carried 
in  Notes  Receivable  account.  While  these 
may  form  legitimate  assets,  they  should  not 
be  included  in  the  account  Notes  Receivable, 
for  the  reason  that  such  transactions  are  only 
incidental  to  and  not  part  of  the  main  pur- 
pose of  the  business.  It  may  further  be  said 
generally  that  all  facts  not  forming  a  neces- 
sary part  of  the  business  should  be  stated 
separately  from  those  facts  which  are  di- 
rectly connected  with  and  form  part  of  the 
business  itself.  If  this  is  not  done  the  bal- 


42    Net  Worth  an'd  the  Balance  Sheet 

ance  sheet  may  lose  much  of  its  meaning  and 
value. 

Thus  the  fact  that  the  Scarborough  Man- 
ufacturing Company  has  on  hand  a  small 
amount  of  notes  received  from  its  customers 
is  one  having  some  significance.  If  the 
actual  amount  of  these  customers'  notes  is 
obscured  with  miscellaneous  obligations,  it 
is  more  difficult  to  picture  the  business  in  its 
own  entirety. 

Notes  Receivable  given  by  subsidiary,  con- 
trolled, or  allied  interests  for  merchandise 
should  be  stated  separately  from  those  re- 
ceived from  outside  customers. 

Where  one  corporation  owns  or  controls  a 
number  of  other  smaller  corporations  whose 
business  forms  part  of  the  whole,  the  main 
company  is  sometimes  referred  to  as  the 
"parent"  company  and  the  other  smaller 
companies  as  "subsidiaries." 

Materials  and  finished  manufactured 
articles  may  be  transported  from  one  to  an- 
other of  these  subsidiary  concerns,  or  from 
the  "parent"  to  one  or  more,  or  from  the  sub- 
sidiaries to  the  parent  corporation.  Again, 


Notes  Receivable  43 

advances  of  money  are  frequently  obtained 
from  the  parent  company  by  the  subsidiary 
concerns.  On  the  books  of  the  parent  com- 
pany such  debts  of  the  subsidiary  companies 
are  sometimes  clearly  shown  to  be  just  what 
they  are,  but  more  often  the  notes  given  to 
the  parent  company  are  included  as  part  of 
the  Notes  Receivable  balance. 

In  some  cases  these  notes  represent  cash 
advanced  for  construction  purposes;  in 
others,  cash  for  current  operating  expenses  ; 
in  others,  the  notes  may  represent  goods  or 
materials  shipped  which  are  either  still  on 
hand  or  which  have  been  sold.  There  are 
as  many  different  things  for  which  these 
notes  may  have  been  given  as  there  are  ways 
of  spending  money.  This  uncertainty  in 
itself  renders  the  statement  more  difficult  of 
understanding  than  it  would  be  if  all  notes 
given  by  one  allied  or  controlled  concern  to 
another  operating  under  the  same  ownership 
were  stated  separately  from  its  ordinary 
Notes  Receivable. 

So  much  for  the  clearness  of  understand- 
ing. There  is  another  reason  for  separating 


44     Net  Worth  and  the  Balance  Sheet 

these  notes,  of  more  importance  in  any  con- 
sideration of  the  real  net  worth  of  a  business. 
It  may  happen  that  many  of  these  notes  rep- 
resent investments  in  enterprises  which  have 
turned  out  to  be  unsuccessful,  and  while  the 
notes  are  being  carried  at  full  value,  they  are 
not  represented  by  full  value  in  the  assets  of 
the  subsidiary  concern. 

In  one  concern  whose  statement  was  re- 
cently examined  it  was  found  that  the 
Notes  Receivable  of  one  of  the  manufactur- 
ing plants  were  held  and  carried  among  the 
other  ordinary  promissory  notes  by  the  main 
organization  to  the  extent  of  $1,000,000, 
while  the  total  capital  stock  of  the  subsidiary 
concern,  all  owned  by  the  parent  company, 
amounted  to  only  $100,000.  The  capital 
needed  by  the  small  concern,  not  only  for  con- 
struction purposes,  but  also  for  materials 
and  labor,  had  been  supplied  by  the  parent 
company.  Since  the  subsidiary  company,  at 
the  time,  was  doing  very  badly,  it  was  a  grave 
question  whether  the  assets  of  the  parent 
company  represented  by  these  notes  were  of 
any  material  value. 


Notes  Receivable  45 

There  was  no  doubt  whatever  that  the 
statement  of  Notes  Receivable  was  mislead- 
ing, containing  as  it  did  this  large  amount 
of  notes  representing  anything  but  ordinary 
Notes  Receivable  from  customers.  It  was 
misleading  to  the  extent  that  without  inquiry 
it  would  have  appeared  that  the  parent  cor- 
poration possessed  a  much  larger  amount  of 
what  is  known  as  "quick"  assets  than  was 
actually  the  case. 

Notes  Assigned  or  Pledged 

Any  notes  assigned  or  pledged  as  collateral 
for  loans  should  be  stated  and  the  liability  for 
the  borrowed  money  shown  as  a  liability. 

Ordinarily  business  concerns  having  a 
credit  standing  are  able  to  borrow  such  funds 
as  are  needed  for  temporary  purposes  upon 
their  own  promissory  notes,  which  they  dis- 
count at  bank.  But  when  they  are  compelled 
to  offer  security  additional  to  that  of  their 
own  established  credit  standing,  they  may 
take  to  the  bank  or  banks,  as  collateral  for 
these  loans,  such  promissory  notes  as  they 
have  received  from  their  customers. 


46    Net  Worth  and  the  Balance  Sheet 

If  such  promissory  notes  have  been  re- 
ceived in  the  ordinary  course  of  business 
from  responsible  concerns,  and  the  date  of 
maturity  and  places  of  payment  are  not  far 
distant,  it  is  quite  within  the  ordinary  for  the 
holders  to  discount  them  at  the  bank, 
although  it  is  generally  regarded  as  better 
financing  for  business  houses,  wherever  pos- 
sible, to  hold  such  notes  until  maturity,  in  the 
meantime  borrowing  for  their  requirements 
on  their  own  notes. 

But  in  many  lines  of  business  custom  re- 
quires that  settlements  be  accepted  for  goods 
sold,  in  long-term  notes.  In  other  lines  the 
business  is  such  that  the  sellers  have  to  take 
many  very  small  notes.  In  such  cases  the 
notes  received  from  customers  do  not  in 
themselves  constitute  very  desirable  loans 
from  a  banker's  standpoint,  and,  as  already 
suggested,  money  needed  is  obtained  of  the 
bank  upon  the  concern's  own  notes,  with 
these  long-term  or  numerous  small  notes  as 
collateral.  When  so  taken,  it  is  usual  for  the 
bank  or  banker  to  collect  these  collateral 
notes  when  due  and  credit  the  amount  col- 


Notes  Receivable  47 

lected  to  the  Bills  Payable  of  the  concern 
borrowing  the  money. 

For  the  sake  of  clearness,  as  has  been  said, 
the  Notes  Receivable  taken  from  customers 
and  pledged  as  collateral  should  remain  as 
Notes  Receivable  on  the  books  of  the  concern 
owning  them,  the  amounts  of  payment  being 
credited  as  reported  by  the  bank. 

For  example: 

Notes  Payable $1,000 

To  Notes  Receivable $1,000 

Note  J.  Watkins,  due  December  3ist,  paid  and 
applied  to  our  loan  at  First  National  Bank. 

In  the  balance  sheet  the  amount  of  the 
Notes  Receivable  pledged  should  be  set  out  in 
a  separate  item  and  designated  as  pledged, 
and  the  amount  borrowed  should  appear  as 
Bills  Payable  in  the  liabilities. 

In  the  case  of  the  Scarborough  Manufac- 
turing Company  no  such  expedient  was 
necessary.  The  aggregate  of  the  Notes  Re- 
ceivable is  small  and  the  working  capital 
owned  and  borrowed  sufficiently  large  for  its 
needs. 


CHAPTER   VI 
ACCOUNTS  RECEIVABLE 

ACCOUNTS  RECEIVABLE  means  the 
sum  total  of  unsettled  charges  against 
debtors,  usually  for  merchandise  sold  and  de- 
livered. 

When  used  in  a  general  sense,  this  term 
may  include  any  legal  demand  or  claim  aris- 
ing out  of  verbal  or  written  contract  not  evi- 
denced by  draft,  promissory  note,  judgment, 
or  mortgage  of  record. 

In  other  words,  an  open  book  debit  against 
any  person  may  consist  in  part  or  in  whole  of 
claims  against  him  which  do  not  represent 
charges  for  delivery  of  the  goods  forming 
the  main  object  or  purpose  of  the  business. 

Examples  may  be  given,  such  as  the  sale 
by  a  dry  goods  merchant  of  his  horses  and 
wagons,  or  by  a  manufacturer,  of  cutlery, 
of  old  machinery,  etc.,  which,  though  proper 
enough  charges,  are  not  charges  for  goods 
manufactured  or  traded  in. 

48 


Accounts  Receivable  49 

When  used  in  a  more  restricted  sense,  the 
term  "Accounts  Receivable"  is  usually  un- 
derstood to  include  only  unsettled  charges  to 
customers  for  merchandise  or  manufactured 
product  sold  on  ordinary  trade  terms,  the 
right  to  collect  which  has  not  been  trans- 
ferred or  assigned. 

This  restricted  sense  is  that  which  is  given 
to  the  usual  customers'  debit  balances.  In 
some  retail  lines  the  open  book  accounts  are 
styled  "Charge  Accounts"  as  distinguished 
from  cash  sales. 

In  gas,  water,  and  electric  light  and  power 
company  accounting  the  unpaid  charges  are 
usually  styled  "Consumers'  Accounts"  or 
"Due  from  Consumers." 

Referring  to  the  suggestion  that  Accounts 
Receivable  should  not  include  those  accounts 
which  have  been  transferred  or  assigned, 
perhaps  it  will  be  well  to  explain  that  some- 
times merchants  and  manufacturers,  finding 
it  difficult  to  obtain  sufficient  accommodation 
for  their  financial  needs  at  their  banks, 
arrange  with  trust  companies  or  bankers  for 
loans  on  their  bills  for  goods  sold, 


50     Net  Worth  and  the  Balance  Sheet 

When  this  is  done  the  bills,  instead  of 
being  at  once  mailed  to  the  customers,  are 
first  taken  in  lots  to  the  trust  company  or 
to  the  banker,  and  about  75,  or  even  80,  per 
cent,  of  the  amount  of  such  bills  is  advanced 
to  the  merchant  or  manufacturer.  The  trust 
company  or  banker  then  takes  possession  of 
the  bills  and  forwards  them  to  the  customers, 
first  stamping  them  with  a  direction  to  the 
customer  to  remit,  not  to  the  merchant  or 
manufacturer  from  whom  the  goods  were 
purchased,  but  instead  to  the  trust  company 
or  banker  whose  name  appears  in  the 
stamped  direction. 

The  business  man  obtaining  money  in  this 
way  should  keep  a  careful  record  of  the  bills 
upon  which  his  loans  are  obtained.  The 
money  received  as  an  advance  should  of 
course  be  entered  in  his  cash  book  as  a  charge 
to  cash,  with  the  necessary  interest  and  com- 
mission adjustment,  and  the  liability  be  cred- 
ited in  the  proper  book  of  record  to  "Loans 
on  Assigned  Accounts." 

In  preparing  his  statement  of  net  worth 
when  such  loans  are  made,  the  amount  of  un- 


Accounts  Receivable  51 

assigned  Accounts  Receivable  should  be 
stated  first,  followed  by  the  total  face  value 
of  the  "Accounts  Receivable  Assigned,"  each 
and  all  of  which  should  be  plainly  designated 
on  the  ledger  as  assigned.  As  the  accounts 
are  paid  to  the  trust  company  or  banker  and 
reported  to  the  merchant  or  manufacturer, 
he  should  enter  in  his  journal  credits  to  his 
customers  for  the  amounts  collected,  and  at 
the  same  time  enter  debits  or  charges  of 
corresponding  amounts  to  the  account  called 
"Loans  on  Assigned  Accounts."  Thus  at 
any  given  time  the  balance  of  the  account 
will  show  the  actual  amount  of  the  money 
owed  to  the  bank,  and  the  total  of  the  "Ac- 
counts Receivable  Assigned"  will  show  the 
face  value  of  those  accounts  assigned  and 
not  paid  by  the  customers. 

As  used  in  the  restricted  sense,  Accounts 
Receivable  should  not  include  money  loaned 
or  advanced  to  any  person  for  any  purpose. 

In  order  that  a  business  man  may  intelli- 
gently inspect  his  true  financial  position  in 
business,  he  should  not  fall  into  the  habit  of 
carrying  records  of  outside  transactions  upon 


52     Net  Worth  and  the  Balance  Sheet 

his  business  books  of  account.  Investments, 
loans,  contributions  to  syndicates,  or  ac- 
counts with  individuals  for  any  one  or  more 
of  a  multitude  of  transactions  which  may 
give  rise  to  charges  on  open  book  accounts, 
ought  not  to  be  mixed  in  with  the  accounts 
relating  solely  to  the  business  of  which  the 
books  purport  to  constitute  a  record. 

If  such  outside  transactions  are  recorded 
on  his  books  he  should  set  out  such  accounts 
separately  from  those  representing  the  main 
business. 

Good  Accounts  Receivable 

When  Accounts  Receivable  are  described 
or  appraised  as  "good,"  it  is  understood  that 
the  amounts  included  in  the  total  so  desig- 
nated are  (a)  not  yet  due  according  to  the 
terms  of  the  sale  and  no  information  has  been 
received  creating  doubt  of  the  customers'  re- 
sponsibility and  readiness  to  pay  when  due, 
or  (b)  are  overdue,  but  experience  with  such 
customers  in  the  past  has  been  such  as  to 
warrant  the  reasonable  belief  that  they  will 
pay  within  a  reasonable  time. 


Merchandise  53 

The  total  of  overdue  accounts,  especially 
after  request  or  demand  for  payment,  should 
not,  as  a  rule,  be  considered  worth  face  value 
in  a  carefully  prepared  statement  of  financial 
condition,  but  a  deduction  should  be  made 
for  possible  losses  on  collection. 

In  a  conscientious  effort  to  prepare  an  ac- 
curate statement  of  net  worth,  the  debit  bal- 
ances or  open  book  accounts  with  customers 
should  be  carefully  analyzed.  Of  course  no 
one  can  forecast  the  future  action  of  any  cus- 
tomer with  absolute  accuracy.  Furthermore, 
customers  who  in  ordinary  times  pay  their 
bills  regularly  may  be  entirely  upset  in 
periods  of  business  depression.  Under  such 
conditions,  men  believed  to  be  absolutely  re- 
liable do  such  strange  things  that  their  prob- 
able course  in  any  given  transaction  cannot 
be  foreseen.  At  the  same  time,  a  thorough 
analysis  of  the  open  balances  will  throw 
much  light  upon  accounts  the  value  of  which, 
considered  as  an  aggregate  without  analysis, 
may  be  difficult  to  estimate. 

Overdue  Accounts 
Taking  the  general  terms  of  the  trade,  as 


54     Net  Worth  and  the  Balance  Sheet 

well  as  any  specific  terms  to  certain  custom- 
ers into  consideration,  an  analysis  should  be 
made  of  each  account  and  the  average  date 
of  the  charges  for  unpaid  merchandise  ascer- 
tained. These  accounts  should  then  be 
classified  according  to  age,  as  follows: 

Analysis  of  Overdue  Accounts 
Under  30  days  overdue 
Over    30  days,  but  less  than  60  days 
Over    60  days,  but  less  than  90  days 
Over    90  days,  but  less  than  6  months 
Over      6  months,  but  less  than  9  months 
Over      9  months,  but  less  than  I  year 
Over       i  year  overdue 

Careful  examination  should  be  made  of 
those  accounts  appearing  under  the  "over- 
due" headings,  taking  the  terms  of  sale  into 
consideration.  No  matter  how  much  confi- 
dence a  merchant  or  manufacturer  may  have 
in  his  customers,  he  cannot  consistently  claim 
as  absolutely  good,  assets  accounts  found  in 
the  "over  90  days"  column,  which,  by  the 
terms,  were  due  in  30  days  from  date  of  sale. 

While  in  many  individual  cases  he  may  be 
very  sure  that  the  customers  will  pay  in  time, 
yet  on  the  whole  the  chances  are  unfavorable 


Accounts  Receivable  55 

that  all  of  those  falling  within  the  delinquent 
90-day  class  will  pay  the  full  amount  of  their 
debts.  And  so  on,  until  he  finds  accounts 
over  a  year  old,  though  due  in  60  days  from 
date  of  sale.  He  could  not  reasonably  count 
on  realizing  the  full  value  of  all  of  such  ac- 
counts unless  he  holds  some  security  or  pos- 
sesses some  special  information  regarding  all 
the  individuals  in  this  excessively  delinquent 
class,  which  would  take  them  out  of  the  gen- 
eral rule. 

Many  credit  men  are  very  suspicious  of  all 
accounts  not  paid  for  after  60  days  from  the 
promised  day  of  payment.  To  throw  out 
of  asset  valuation  each  and  every  such  ac- 
count would  be  just  as  unreasonable  as  to 
include  all  old  accounts  at  their  face  value. 

Careful  inquiry  of  his  clerks  regarding  the 
steps  taken  to  collect  overdue  accounts  will 
often  lead  the  merchant  or  manufacturer  to 
a  definite  conclusion,  not  perhaps  that  any 
account  apparently  good  is  absolutely  worth- 
less, but  that,  considered  as  an  asset,  he 
ought  not  to  take  it  in  his  statement  at  full 
value. 


A 


CHAPTER  VII 

ACCOUNTS  RECEIVABLE  (continued) 
CCOUNTS  subject  to  discount,  allow- 


ance, rebate,  claims  for  damaged  or 
imperfect  goods,  or  known  to  be  doubtful  for 
any  reason,  should  be  deducted  to  the  extent 
of  the  known  or  estimated  shrinkage  to  occur 
in  final  settlement. 

Of  course,  all  known  bad  debts  should  be 
closed  out  and  charged  to  the  Profit  and  Loss 
account.  Those  accounts  not  known  to  be 
bad  or  even  doubtful,  which  on  their  face  are 
delinquent,  and  thus,  according  to  general 
credit  knowledge,  not  worth  face  value, 
should  be  partially  offset  by  means  of  a  re- 
serve set  aside  from  the  profits  for  bad  or 
'doubtful  debts. 

It  is  customary  to  charge  off  bad  debts, 
and  close  the  accounts  of  those  from  whom 
it  appears  impossible  to  collect  the  amounts 
due.  It  sometimes  happens,  however,  that 
changes  in  circumstances  make  it  possible  to 

56 


Accounts  Receivable  57 

collect  accounts  subsequently  which  appeared 
worthless  at  the  time  they  were  charged  off. 
A  separate  book  or  ledger  should  be  kept  con- 
taining records  of  all  bad  debts.  This  book 
should  be  frequently  scrutinized  that  known 
changes  for  the  better  in  any  of  the  old 
debtors  may  not  be  overlooked. 

Unsettled  Charges 

No  unsettled  charges  against  any  individ- 
ual connected  zvith  the  business,  either  as 
a  proprietor,  stockholder,  officer,  or  clerk, 
whether  for  overdrawn  salary  accounts,  ex- 
pense accounts,  unpaid  stock  subscriptions, 
or  for  any  other  reason,  should  be  included  in 
Accounts  Receivable,  but  should  be  stated 
separately. 

It  is  frequently  observed  that  overdrawn 
salary  accounts  are  carried  in  the  Accounts 
Receivable  as  balances  due  from  the  officers 
or  clerks  who  have  overdrawn ;  and  in  some 
cases  partners  maintain  open  drawing  ac- 
counts indefinitely,  including  the  debit  bal- 
ances in  the  same  class  as  balances  due  from 
customers. 


58     Net  Worth  and  the  Balance  Sheet 

Again,  large  advances  of  cash  are  some- 
times made  to  agents  or  salesmen  either  on 
account  of  salaries  or  commission,  or  for 
expense  funds.  It  would  seem  needless  to 
say  that  such  accounts  are  not  Accounts  Re- 
ceivable in  the  understood  sense  of  the  term, 
if  it  were  not  for  the  fact  that  some  business 
men  and  bookkeepers  include  all  open  debit 
balances  against  individuals  in  this  one  class. 

Collecting  Accounts  Receivable 

The  elimination  from  Accounts  Receivable 
of  every  kind  of  debit  charge  other  than  for 
goods  sold,  is  useful  in  more  than  one  way. 
Besides  the  assistance  rendered  in  determin- 
ing the  net  worth  of  a  business,  the  amount 
of  outstanding  debit  accounts  for  merchan- 
dise sold,  taken  into  connection  with  the  vol- 
ume of  sales,  throws  light  on  the  financial 
ability  of  the  management — a  light  which 
should  be  of  help  to  the  management  in  cor- 
recting the  weaknesses  disclosed. 

After  learning  the  terms  of  credit  on 
which  goods  have  been  sold,  a  simple  compu- 
tation based  on  the  terms  of  credit,  volume 


Accounts  Receivable  59 

of  sales,  and  the  amount  of  Accounts  Receiv- 
able, will  show  whether  or  not  the  collections 
have  been  made  promptly.  For  example,  the 
Scarborough  Manufacturing  Company  sold 
during  the  year  1911  an  aggregate  of 
$680,000  on  various  terms  of  credit,  the  aver- 
age of  which  would  be  about  45  days.  The 
amount  outstanding  was  approximately  the 
same  at  the  beginning  as  at  the  end  of  the 
year,  i.e.,  $111,172.08;  whereas  the  Accounts 
Receivable,  if  collected  according  to  the 
terms  of  credit,  would  amount  at  any  one 
time  to  not  over,  approximately,  one-eighth 
of  the  total  sales,  or  about  $85,000. 

The  actual  amount  of  the  Accounts  Re- 
ceivable is  therefore  about  $25,000  greater 
than  the  average  term  of  credit  would  indi- 
cate as  necessary. 

Of  course  this  rule  must  not  be  taken  as  a 
basis  for  final  judgment  without  further  in- 
quiry, but  on  its  face  the  Scarborough  Manu- 
facturing Company's  collection  department 
has  been  too  easy  with  its  customers  for  its 
own  good. 

Not  long  since,  the  annual  sales  of  each  of 


60    Net  Worth  and  the  Balance  Sheet 

two  concerns  in  the  same  line  of  business 
aggregated  about  $1,000,000.  One  con- 
cern carried  $400,000  of  Accounts  Receiv- 
able, while  the  other  succeeded  in  keeping  its 
customers'  accounts  down  to  only  $200,000, 
or  100  per  cent,  less  than  the  more  easy-going 
concern.  As  a  result  the  first  was  obliged  to 
borrow  heavily  and  pay  interest  on  the 
amount  borrowed — a  tax  on  the  business 
which  would  not  have  been  needed  if  it  had 
collected  the  accounts  due  to  it.  Besides  this, 
the  danger  of  loss  through  accounts  grows 
with  the  length  of  time  the  accounts  are  al- 
lowed to  remain  uncollected. 

Accounts  Receivable  from  Allied  Interests 

Accounts  Receivable  representing  un- 
settled charges  against  subsidiary,  controll- 
ing, or  allied  interests  should  be  stated 
separately. 

Many  interconnected  companies  buy  of 
and  sell  to  each  other,  piling  up  large  Ac- 
counts Receivable  and  Payable,  which  are 
not  of  such  character  as  to  be  properly  in- 
cluded in  the  same  class  as  accounts  due  from 


Accounts  Receivable  61 

outside  parties.  In  some  cases,  of  course,  the 
concerns,  though  controlled,  are  sufficiently 
distinct  to  permit  transactions  between  them 
to  be  regarded  as  similar  to  those  of  entirely 
separate  concerns.  But  in  many  instances 
the  charges  for  goods  delivered  by  one  of 
the  subsidiary  concerns  of  a  large  corpora- 
tion to  another  of  the  concerns  amounts  to 
nothing  more  than  a  transfer  of  materials  or 
merchandise  from  one  plant  to  another. 

Where  commission  merchants  having  mer- 
chandise in  their  possession  owned  by  manu- 
facturers, advance  funds  to  the  owners  of  the 
merchandise  in  anticipation  of  sales,  the 
amount  advanced  should  not  be  included  in 
Accounts  Receivable.  Such  advances  should 
be  separately  stated  and  described  as  "Ad- 
vances of  Cash  Against  Merchandise  in  Our 
Possession  for  Sale  on  Commission." 


CHAPTER   VIII 
MERCHANDISE 

HP  HIS  account  in  a  balance  sheet  is  in- 
tended to  mean  unsold  marketable 
goods  and  wares  owned  by  a  merchant  and 
bought  for  sale,  these  goods  being  of  any 
kind  falling  within  the  general  purpose  of  his 
business. 

Reference  is  made  here  to  the  merchan- 
dise of  a  merchant  or  trader.  The  finished 
product  of  a  manufacturer  is  described  in  a 
later  chapter. 

Valuation  of  Merchandise 

With  certain  exceptions,  the  inventory 
value  of  merchandise  should  be  based  upon 
purchase  price  plus  freight  charges,  and,  in 
some  cases,  expenses  incident  to  carrying  the 
stock. 

Some  merchants  and  manufacturers  cal- 
culate the  inventory  at  full  selling  price,  or  at 
selling  price  less  certain  discounts,  but  ex- 

62 


Merchandise  63 

cept  in  a  few  particular  cases  this  method  is 
not  in  accordance  with  the  best  business 
principles. 

According  to  the  views  of  such  merchants 
and  manufacturers,  the  moment  goods  are 
bought  or  manufactured  and  ready  for  sale,  a 
value  attaches  to  them  corresponding  to  the 
demand  of  the  consumers.  The  price  which 
the  purchaser  is  willing  to  pay  for  the  goods 
constitutes  that  value,  they  argue,  and  that 
price  is  the  amount  at  which  the  merchant 
should  be  allowed  to  appraise  his  goods  in 
stock. 

On  the  other  hand,  until  the  goods  are  ac- 
tually sold  and  accepted  by  the  purchaser, 
the  goods  actually  belong  to  the  merchant  or 
manufacturer,  although  it  is  true  that  cases 
exist  in  which  the  legal  phases  of  the  con- 
tract between  the  vendor  and  vendee  produce 
conditions  whereby  it  would  be  perfectly 
justifiable  for  the  merchant  or  manufacturer 
to  value  his  goods  at  full  price. 

Again,  there  are  lines  of  business  in  which 
the  articles  dealt  in  are  constantly  fluctuating 
in  price,  due  more  or  less  to  the  speculative 


64     Net  Worth  and  the  Balance  Sheet 

value  of  the  article,  as,  for  example,  flour  and 
cotton. 

Such  cases  may  form  exceptions  to  the 
general  rule  and  must  be  considered  carefully, 
but  if  a  valuation  on  merchandise  is  fixed 
above  cost,  the  result,  according  to  the  ordi- 
nary methods  of  bookkeeping,  will  be  a  show- 
ing on  the  books  of  a  profit  not  yet  earned. 

By  "not  yet  earned"  is  meant  that  the 
goods  have  not  yet  been  actually  sold  and 
accepted.  Up  to  that  point  the  goods  belong 
to  the  merchant.  When  the  goods  have  been 
sold  and  accepted,  the  asset  is  changed  from 
the  asset  "Stock  on  Hand"  to  an  asset  con- 
sisting of  a  claim  against  a  supposedly  re- 
sponsible party.  That  change  in  the  legal 
status  seems  to  form  the  most  appropriate 
marking  point  for  the  taking  on  the  books  of 
a  profit. 

In  some  lines  goods  are  ordered  by  the 
purchaser  six  months  in  advance  of  delivery. 
In  such  cases  it  would  seem  that  at  inven- 
tory time  such  goods  as  are  on  hand,  having 
been  manufactured  on  order,  should  be  val- 
ued at  selling  price  less  expenses  of  carrying 


Merchandise  65 

in  stock  and  delivery  to  the  point  agreed 
upon.  This  method  seems  to  be  correct  on 
the  principle  that  the  goods  actually  belong 
to  the  purchaser,  and  since  he  is  bound  to 
take  and  pay  for  them,  the  profit  to  the  man- 
ufacturer has  already  been  earned. 

In  the  exceptional  cases  referred  to,  such 
would  be  the  fact,  and  such  a  method  of 
treatment  would  be  correct,  but  the  cases  are 
comparatively  rare  in  which  the  goods, 
though  still  in  the  manufacturer's  actual 
possession,  have  in  law  been  delivered  to  the 
customer  and  are  simply  held,  subject  to  his 
order  and  at  his  own  risk. 

A  fairly  accurate  test  of  the  matter  in 
each  case  may  be  applied  in  the  form  of  this 
question:  ''In  the  event  of  destruction  of  the 
goods  by  fire,  on  whom  would  fall  the  loss?" 

If  the  answer  is  clear  to  the  effect  that  the 
customer  would  be  the  loser,  the  manufac- 
turer is  justified  in  considering  the  goods  as 
sold.  If,  on  the  other  hand,  under  the  terms 
of  the  contract  of  sale,  the  goods,  though 
ordered  and  manufactured,  are  still  the  prop- 
erty of  the  manufacturer  to  the  extent  that 


66    Net  Worth  and  the  Balance  Sheet 

their  loss  or  damage  by  fire  would  fall  on 
him,  he  is  not  justified  in  considering  them 
sold.  Cancellations  may  come  in  before  de- 
livery and  after  delivery  the  goods  may  not 
be  accepted. 

By  whatever  means  effected,  delivery, 
either  actual  or  constructive  in  law,  must  be 
made  to  the  customer  and  the  goods  be  ac- 
cepted by  him  as  to  price,  quantity,  and  qual- 
ity before  their  ownership  passes. 

When,  however,  the  cost  of  the  merchan- 
dise at  inventory  time  for  any  reason  exceeds 
the  market  value,  the  latter  should  form  the 
basis  of  the  valuation ;  the  reason  being  that 
the  inventory  at  cost  compared  with  market 
value  shows  a  known  loss,  which  should  be 
deducted  from  the  value  of  the  merchandise 
at  once. 

A  frequent  instance  of  overvaluation  is 
found  in  merchandise  which  was  once  sal- 
able, but  which  has  become  worn,  or  out  of 
style.  Such  articles  are  sometimes  carried 
in  stock  under  the  heading  of  "discontinued 
numbers."  Whatever  the  reason  for  their 
depreciation  in  value,  articles  of  merchandise 


Merchandise  67 

not  worth  what  they  cost  should  not  be  car- 
ried at  more  than  their  real  value. 

The  exceptional  cases  in  which  the  general 
rule  as  to  valuation  does  not  hold  are  those 
wherein  the  nature  of  the  business  is  such 
that  the  market  or  selling  price  furnishes 
the  most  practical  basis  for  the  true  ascer- 
tainment of  the  financial  position  of  the  mer- 
chant. 

Manufacturers  of  paint  and  linoleum  seem 
to  furnish  instances  of  this  kind.  The  con- 
trolling ingredient  in  the  manufacturing  of 
these  articles  is  linseed  oil,  the  price  of  which 
varies  considerably,  according  to  numerous 
factors  which  affect  the  market  price.  At 
the  end  of  the  year  1911  the  price  of  this  oil 
was  about  seventy-one  cents  per  gallon,  while 
during  the  year  the  average  cost  was  eighty- 
five  cents  per  gallon.  This  condition  in  the 
linseed  oil  market  during  the  year  produced 
a  cost  above  market  price  at  the  end  of  the 
year  for  such  articles  manufactured  from 
the  higher  priced  oil  as  were  then  on  hand. 
In  many  cases  at  the  end  of  the  year  paint 
and  linoleum  concerns  reduced  the  inventory 


68     Net  Worth  and  the  Balance  Sheet 

valuation  of  finished  goods  to  a  basis  of  the 
price  of  oil  at  the  time  the  inventory  was 
taken. 

But  suppose  the  price  of  linseed  oil  was 
considerably  higher  at  the  close  of  the  year 
than  it  had  been  during  the  year.  Would 
the  manufacturers  be  justified  in  increasing 
the  inventory  valuation  of  finished  stock  to 
agree  with  the  higher  priced  oil  ?  The  justi- 
fying argument  advanced  by  some  in  support 
of  this  course  is  that  if  the  sales  for  the  next 
year  are  based  upon  the  actual  cost  price  of 
oil  during  the  preceding  year,  a  loss  would 
occur  which  would  not  be  incurred  if  the  in- 
ventory of  manufactured  goods  at  the  close 
of  the  year  was  based  upon  the  cost  of  oil  at 
the  end  of  the  year. 

This  argument  is  used  by  those  who  think 
of  the  cost  of  an  article  as  having  a  necessary 
relation  to  the  selling  price,  and  that  the  cost 
once  found  may  be  used  for  a  year  in  ad- 
vance. This  idea  confuses  the  actual  cost 
of  manufacturing  in  the  past  with  estimates 
on  which  prices  are  fixed  in  advance  for 
future  sales. 


Merchandise  69 

While  actual  cost  records  should  be  con- 
sulted very  carefully  in  making  up  schedules 
of  present  or  future  prices,  it  must  be  remem- 
bered that  the  cost  figures  are  obtained  from 
past  happenings  and  may  not  be  safely  relied 
upon  as  the  sole  guide  for  future  costs  or 
prices. 

When  the  price  of  an  article  is  made  and 
the  cost  price  must  enter  into  the  considera- 
tion, each  item  of  the  latest  cost  record  of  that 
article  should  be  examined  in  the  light  of 
later  knowledge  of  market  and  labor  con- 
ditions and  probable  future  conditions,  so 
that  the  future  cost  may  be  estimated  as 
nearly  as  possible  in  accordance  with  antici- 
pated future  happenings. 

Looking  at  costs  and  prices  from  this  point 
of  view,  it  will  be  seen  that  the  inventoried 
cost  of  an  article  at  the  end  of  the  year  may 
be  taken  at  actual  cost,  or  market  price  if 
that  is  lower  than  cost,  and  the  estimates  on 
which  prices  for  the  following  year  are  based 
may,  without  inconsistency,  be  taken  at  en- 
tirely different  or  even  purely  supposititious 
figures. 


70    Net  Worth  and  the  Balance  Sheet 

Therefore,  even  in  the  case  of  oil,  higher 
priced  at  the  end  of  the  year  than  the  aver- 
age price  during  the  year,  the  rule  of  taking 
actual  cost  when  lower  than  market  value 
would  not  only  be  sound,  but  would  at  the 
same  time  be  in  accordance  with  conserva- 
tive management,  and,  as  has  been  seen,  it 
need  not  conflict  with  subsequent  price- 
making. 

Merchandise  on  Hand 

Merchandise  on  Hand  should  include  all 
merchandise  actually  in  the  merchant's  store 
or  warehouse,  or  out  on  approval,  and  all 
merchandise  purchased  by  him,  not  yet  de- 
livered, but  which  he  must  receive  and  pay 
for;  but  it  should  not  include  merchandise 
ordered  but  not  received  or  accepted,  which 
by  the  terms  of  the  purchase  he  may  cancel 
before  delivery,  or  refuse  to  accept  upon  de- 
livery. 

Any  merchandise  pledged  for  loans  should 
be  stated  separately  from  the  amount  of  mer- 
chandise unpledged,  and  the  liability  for  the 
borrowed  money  should  be  shown  as  a  lia- 


Merchandise  71 

bility.  Frequently  concerns  handling  mer- 
chandise of  considerable  value  are  able  to 
obtain  loans  upon  the  pledge  of  that  material 
as  collateral.  Sometimes  the  merchandise  is 
placed  in  the  actual  possession  of  the  bank 
loaning  the  money,  but  more  often  the  evi- 
dence of  its  existence  is  in  the  form  of  ware- 
house certificates  or  bills  of  lading. 

Any  merchandise  held  for  sale  on  consign- 
ment, or  in  trust  for  any  purpose,  not  abso- 
lutely owned  by  the  merchant,  should  not  be 
included  in  the  inventory,  which  is  intended 
to  show  only  such  materials  or  merchandise 
as  is  owned. 


CHAPTER  ix 

FINISHED  PRODUCT 

IN  I  SHED  PRODUCT  means  unsold 
completely  manufactured  marketable 
articles  made  and  owned  by  a  manufacturer 
and  in  his  possession  at  his  factory  or  mill, 
or  at  warehouses  or  branches  or  agencies. 

In  other  words,  this  means  the  ordinary 
goods  produced  by  the  manufacturer  and 
ready  for  sale. 

It  will  be  noted  that  a  distinction  is  made 
between  the  merchandise  of  a  merchant  and 
the  product  of  a  manufacturer.  This  is  a 
distinction  which  indicates  that  merchandise 
is  bought  and  sold  by  merchants,  while  the 
finished  product  represents  materials  bought 
and  labor  expended  in  producing  the  articles 
manufactured.  The  finished  product  of  a 
factory  may  consist  of  merchandise  ready 
for  the  final  consumer,  who  purchases  it 
from  the  manufacturer  direct  or  from  mer- 
chants. 

72 


Finished  Product  73 

Some  manufacturers  accommodate  their 
customers  by  supplying  articles  not  man- 
ufactured by  them,  but  which  are  traded 
in  or  used  by  customers  buying  the  main 
articles  manufactured.  An  example  is  found 
in  a  paint  company  which  manufactures 
nothing  besides  paints,  but  which  carries  a 
small  stock  of  brushes,  sand  paper,  glass  and 
similar  articles  for  the  accommodation  of  its 
customers.  In  such  cases  the  inventory 
should  be  classified  so  as  to  show  the  total 
of  the  raw  material,  the  partly  finished  and 
finished  product,  and  also  the  merchandise 
purchased  from  others  for  use  in  supplying 
customers. 

Manufacturing  Cost 

The  valuation  of  finished  product  should 
be  based  upon  cost,  including  a  proper  pro- 
portion of  the  expenses  of  manufacturing 
and  caring  for  the  stock  to  the  time  of  in- 
ventorying. 

Just  what  expenses  may  properly  be  added 
to  the  manufactured  product  of  a  factory 
to  determine  its  cost  cannot  be  enumerated 


74     Net  Worth  and  the  Balance  Sheet 

and  described  in  detail  in  such  manner  as  to 
establish  an  exact  rule  for  the  guidance  of 
all  manufacturers.  In  general  it  may  be  said 
that  the  manufacturing  cost  of  a  finished 
article  is  intended  to  include  all  items  enter- 
ing into  the  cost  of  production,  such  as  ma- 
terials, labor  and  overhead  factory  expense. 
Manufacturing  cost  does  not  include  any 
part  of  the  cost  of  advertising  and  selling. 
It  should  include  the  cost  of  that  portion  of 
the  general  administration  devoted  to  pro- 
ducing, but  no  portion  not  strictly  chargeable 
to  manufacturing. 

Perhaps  the  distinction  between  what  may 
be  included  in  manufacturing  cost  and  what 
may  not  will  be  clearly  marked  in  the  item 
of  Bad  Debts,  which  represents  loss  due  to 
error  in  judgment  of  the  salesman  or  credit 
man  or  both,  or  to  unfortunate  turns  of 
events  which  could  not  have  been  foreseen  at 
the  time  the  credit  was  granted. 

Whatever  the  cause  for  the  loss  on  Ac- 
counts Receivable  for  goods  sold,  delivered, 
and  accepted,  the  manufacturing  branch  of 
the  business  cannot  be  charged  with  fault. 


Finished  Product  75 

If  it  cannot  be  charged  to  the  factory,  by  the 
same  reasoning  such  items  do  not  constitute 
part  of  the  manufacturing  cost,  and  thus 
cannot  be  added  as  a  manufacturing  expense 
to  the  valuation  of  the  inventory. 

Briefly,  the  manufacturing  cost  attaches 
to  the  product  up  to  the  time  the  goods  are 
ready  for  delivery  and  have  been  sold.  A 
distinction  might  be  drawn  between  the 
actual  cost  of  manufacture  and  the  expense 
of  storage  up  to  the  time  the  goods  leave  the 
factory,  but  while  the  cost  of  carrying  might 
seem  at  first  blush  to  constitute  storage  cost 
as  distinguished  from  manufacturing  cost, 
an  argument  on  the  other  side  to  the  effect 
that  in  many  lines  goods  cannot  be  sold  un- 
less made  up  and  kept  ready  for  sale,  would 
narrow  the  storage  idea  to  a  line  too  fine  for 
practical  purposes. 

In  some  lines  of  business  goods  are  manu- 
factured upon  orders  considerably  in  ad- 
vance of  the  time  set  for  delivery.  At  in- 
ventory time  many  business  men,  consider- 
ing that  the  ordered  goods  have  been  sold, 
put  the  entire  selling  price  on  such  of  these 


76     Net  Worth  an'd  the  Balance  Sheet 

goods  as  have  not  been  delivered.  Unless  the 
buyer  has  actually  inspected  and  accepted 
the  goods,  they  have  not  really  been  sold,  and 
until  they  are  really  sold  the  manufacturing 
cost  only  should  be  used  as  a  basis  for  valu- 
ation. 

Consigned  Goods 

Finished  Product  should  include  all  articles 
shipped  on  consignment  for  sale  and  account- 
ing to  the  owner.  Some  manufacturers  in- 
clude the  charges  for  such  consigned  goods 
in  the  Accounts  Receivable,  but  these  charges 
do  not  consist  of  actual  sales,  and  the  state- 
ment should  show  what  in  reality  is  a  fact, 
that  certain  articles  of  product  owned  by 
the  manufacturer  have  been  shipped  to  con- 
signees for  sale  and  accounting  for  the  pro- 
ceeds of  the  sale. 

There  are  certain  contracting  enterprises 
which  do  not  fall  under  the  head  of  manu- 
facturing, where  deviations  may  or  must  be 
made  from  this  general  rule.  An  explana- 
tion of  the  special  accounting  terms  used  by 
such  concerns  is  not  included  in  the  present 


Finished  Product  77 

consideration,  which  is  restricted  almost  en- 
tirely to  the  terms  used  by  merchants  and 
manufacturers  engaged  in  the  ordinary  lines 
of  business. 


CHAPTER   X 
PARTLY  FINISHED  PRODUCT 

pARTLY  finished  product  consists  of 
articles  in  process  of  manufacture  at 
the  time  the  inventory  is  taken,  which  are 
intended  to  be  completed  and  become  finished 
and  salable  stock  in  the  ordinary  course  of 
the  business. 

Such  partly  completed  articles  should  be 
valued  at  cost  of  labor  and  material,  plus  a 
proper  proportion  of  the  expenses  of  the 
business  to  the  time  of  inventorying,  as  ex- 
plained under  the  description  of  finished 
stock. 

In  some  lines  of  manufacture  it  is  com- 
paratively easy  to  estimate  the  cost  of  goods 
partly  finished  at  the  time  the  inventory  is 
taken.  In  other  lines  it  is  exceedingly  diffi- 
cult to  estimate  the  amount  of  labor,  ma- 
terial, and  general  manufacturing  expenses 
which  have  been  absorbed  in  the  course  of 
manufacturing  the  articles  not  yet  fully  fin- 

78 


Partly  Finished  Product  79 

ished.  Where  the  total  of  such  articles 
would,  if  correctly  inventoried,  form  an  im- 
portant bearing  upon  the  net  worth,  manu- 
facturing plants  cannot  well  do  without  some 
form  of  cost  accounting  which  will  show 
the  cost  of  the  manufactured  product  in 
every  stage  of  its  progress  through  the  fac- 
tory, from  raw  material  to  its  finished  state. 
It  may  be  simple  to  estimate  the  amount 
of  material  and  direct  labor,  and  even  direct 
expense,  consumed  in  a  partly  finished  article, 
but  the  distribution  of  indirect  or  overhead 
expense — i.e.,  such  expenses  as  cannot  be 
easily  identified  with  any  particular  object 
of  the  many  produced — presents  a  much 
more  difficult  problem.  Some  adequate  plan 
must  be  provided  for  this,  or  otherwise  the 
application  of  such  expenses  at  the  time  of 
inventorying  is  likely  to  lead  to  misrepre- 
sentation in  the  accounts. 

The  Perpetual  Inventory 

Contrasted  with 'the  difficulty  which  every 
manager  who  does  not  have  a  cost  system  ex- 
periences in  placing  the  proper  valuation  on 


80    Net  Worth  and  the  Balance  Sheet 

partly  finished  articles  is  the  comparatively 
simple  problem  presented  to  the  manufac- 
turer whose  cost  records  are  carefully 
planned  and  can  be  safely  used  in  obtaining 
inventory  values.  In  some  concerns  the 
amount  and  cost  of  every  article  in  stock, 
whether  fully  or  partly  manufactured,  can 
be  readily  ascertained  at  any  time.  Some, 
indeed,  maintain  a  perpetual  inventory  of 
all  supplies,  materials,  goods  in  process  of 
manufacture,  and  finished  product.  In  such 
cases  the  actual  inventory  of  unfinished 
product  consists  merely  of  the  verification  of 
its  existence. 

For  this  purpose  a  list  of  the  unfinished 
articles  shown  by  the  records  to  be  in  exist- 
ence in  various  stages  of  manufacture  in  the 
different  departments  of  the  factory  is  pre- 
pared, and  the  actual  weighing  and  counting 
is  undertaken  merely  as  a  proof  of  accuracy, 
in  much  the  same  way  that  a  cashier  counts 
his  cash  in  confirmation  of  the  cash  balance 
shown  in  his  cash  book. 

Ordinarily,  when  information  is  wanted  as 
to  the  amount  of  cash  on  hand,  it  is  not 


Partly  Finished  Product  81 

necessary  for  the  cashier  to  go  to  his  cash 
box  and  by  actual  count  assure  himself  of 
the  contents.  An  actual  count  is  undertaken, 
of  course,  with  sufficient  frequency  to  pre- 
vent mistakes  in  his  actual  cash,  but  for  gen- 
eral purposes  he  may  safely  rely  upon  the 
balance  supposed  to  be  on  hand  as  shown  by 
his  cash  book. 

In  the  same  manner,  properly  planned  and 
maintained  cost  accounts  should  at  any  time 
produce  the  most  satisfactory  information 
as  to  the  quantity  and  cost  of  not  only  the 
raw  materials  and  finished  stock,  but  of  the 
amount  and  cost  of  the  goods  which  have  not 
yet  reached  the  completed  state. 

Parts  of  articles  made  up  in  advance  of 
actual  assembling  into  the  finished  product 
should  be  inventoried  at  cost,  plus  in  some 
cases  a  proper  proportion  of  general  ex- 
penses to  time  of  inventorying  as  explained 
under  Finished  Product. 

In  some  lines  of  manufacture  the  product 
consists  of  complicated  machinery  or  other 
articles,  the  completion  of  which  calls  for 
the  assembling  of  more  or  less  numerous 


82     Net  Worth  and  the  Balance  Sheet 

parts,  which  have  previously  been  manufac- 
tured and  placed  in  the  store-room  awaiting 
an  order  for  the  assembling. 

A  proper  system  of  accounts  will  produce 
the  cost  of  each  one  of  these  parts  so  that 
when  assembled  the  total  cost  of  the  com- 
pleted article  may  be  determined,  and  in  the 
meantime  the  cost  of  each  and  every  part 
may  be  readily  ascertained. 


CHAPTER   XI 
RAW  MATERIALS  AND  SUPPLIES 


term  Raiv  Materials  means  uncon- 
sumed  materials  purchased  and  owned, 
to  be  used  in  the  manufacture  of  the  finished 
product  of  the  manufacturer. 

Raw  materials  in  the  elementary  sense 
mean  nothing  more  nor  less  than  earth  prod- 
ucts, such  as  clay,  ore  of  various  kinds,  and 
timber.  But  as  used  in  the  ordinary  sense 
all  materials  are  raw  materials,  whether  in 
the  raw  state  or  partly  finished,  bought  for 
conversion  through  labor  into  another  state. 
For  example,  brass  pipe  already  manufac- 
tured is  raw  material  for  metal  bed  manu- 
facturers, and  sheet  paper  is  raw  material  in 
the  manufacture  of  books. 

The  valuation  of  raw  materials  should  be 
based  on  the  cost,  plus  freight,  and  a  proper 
portion  of  expense  of  carrying  in  stock  until 
used. 

Materials    not    adapted    to    the   present 

83 


84     Net  Worth  and  the  Balance  Sheet 

shapes,  styles,  or  quality  of  the  product 
should  not  be  included  at  higher  than  scrap 
value, 

Inevitably  in  any  manufacture,  as  the 
shape  and  style  change  from  year  to  year, 
the  stock  of  raw  materials  will  contain  more 
or  less  out-of-date  material,  worth  no  more 
than  scrap  value.  Careful  scrutiny  of  this 
stock  should  be  made  by  the  business  man 
who  does  not  wish  to  deceive  himself  re- 
garding his  real  net  worth. 

Much  of  this  loss  on  materials  may  be 
prevented  if  current  watchful  vigilance  is 
exercised  by  the  manager.  An  unnecessarily 
large  stock  should  not  be  carried.  Old  ma- 
terial should  be  used  up  as  far  as  may  safely 
be  done  before  new  is  purchased.  This  rule  is 
not  always  observed.  It  not  infrequently 
happens  that  requisitions  are  made  by  fore- 
men for  certain  sizes  and  shapes  of  material 
which  do  not  happen  to  be  on  hand,  and  such 
stock  is  ordered  immediately  by  those  hav- 
ing charge  of  the  purchasing  of  material, 
when  the  needs  of  the  foremen  might  be 
accommodated  to  the  stock  in  hand,  and  by 


Raw  Materials  and  Supplies         85 

this  means  its  volume  be  kept  down  to  actual 
needs. 

Supplies  on  Hand 

The  item  Supplies  on  Hand  means  uncon- 
sumed  articles  in  stock,  to  be  used  in  the 
operation  of  a  factory  or  mill,  not  entering 
directly  into  or  forming  part  of  the  finished 
product  itself;  fuel,  oils,  repair  parts  or  ma- 
terials, and  packing  are  examples  of  supplies. 

Supplies,  as  the  term  is  ordinarily  used, 
means  certain  kinds  of  materials  which  must 
be  used  by  every  factory  in  keeping  the  plant 
in  running  order.  This  sort  of  material  does 
not  become  a  part  of  the  manufactured 
goods,  and  in  carefully  planned  accounting 
systems,  records  of  such  supplies  are  kept 
separately  from  material  consumed  in  the 
manufacture  of  the  product.  The  amount 
should  be  kept  down  to  the  minimum  actually 
needed.  The  same  caution  is  required  to 
prevent  overloading  of  supplies  as  is  needed 
to  prevent  too  much  stocking-up  of  raw  ma- 
terials. 

The  valuation  of  supplies  should  be  made 


86    Net  Worth  and  the  Balance  Sheet 

on  the  basis  of  cost  plus  freight,  unless,  of 
course,  the  prices  of  the  supplies  have  dropped 
below  the  original  cost,  when  the  same  rule 
applies  as  to  merchandise.  To  the  cost  may 
be  added  a  proportion  of  the  expense  of 
handling  and  storing. 

Any  worn-out  or  obsolete  article  should 
be  included  in  the  inventory  at  no  higher 
than  scrap  value. 


CHAPTER  XII 
REAL  ESTATE 

JN  general,  the  term  Real  Estate  includes 
any  interest  in  lands.  A  more  restricted 
use  excludes  all  other  interest  than  actual 
'ownership  in  fee  of  such  land  and  buildings 
as  are  used  in  the  operation  of  the  business. 

Real  Estate  should  be  valued  at  cost,  less 
depreciation.  There  are  cases  in  which  the 
value  of  the  land  increases  to  an  extent  suffi- 
cient to  offset  the  depreciation  of  the  build- 
ings, and  there  are  certain  cases  in  which 
the  merchant  or  manufacturer  would  be 
warranted  in  increasing  the  amount  at  which 
the  real  estate  is  carried  on  his  books,  but 
in  business  circles  it  is  a  general  rule  that 
such  increase  should  not  be  placed  on  the 
books. 

Logically,  there  is  no  reason  why  the  book 
accounts  representing  assets  should  not  be 
"written  up"  where  book  values  are  below 
actual  values.  If  a  manufacturer  "writes 

87 


88    Net  Worth  and  the  Balance  Sheet 

down"  the  book  value  to  provide  against 
possible  depreciation,  he  ought  from  every 
consideration  of  pure  reason  be  allowed  to 
write  up  his  assets  when  their  value  exceeds 
the  book  value.  In  other  words,  if  an  ad- 
justment of  book  values  to  correspond  with 
facts  is  to  be  commended,  the  rule  requiring 
such  adjustment  ought  to  work  both  ways, 
up  as  well  as  down. 

As  a  matter  of  practice,  while  many  cases 
of  "writing  up"  are  not  founded  on  facts 
sufficiently  established  to  warrant  it,  there 
are  cases  in  which  the  writing  up  is  not  ob- 
jectionable. If  the  method  of  bookkeeping 
employed  calls  for  adjustments  up  and  down 
in  definitely  expressed  accounts,  the  "appre- 
ciation" of  value  would  not  constitute  an 
addition  to  the  asset  account  itself,  but  would 
call  for  the  opening  of  another  asset  account, 
called  "Appreciation  of  Real  Estate,"  with 
a  corresponding  surplus  account,  probably 
called  "Real  Estate  Appreciation  Surplus." 

This  suggestion  is  in  accordance  with  the 
opposite  principle  of  depreciation  by  which 
all  plant  accounts  should  be  kept  in  such  a 


Real  Estate  89 

way  as  to  show  actual  cost,  with  any  esti- 
mated depreciation  shown  separately  as  a 
reserve  account. 

If  the  merchant  or  manufacturer  occupies 
his  premises  as  lessee,  he  should  not  include 
the  lease  in  real  estate,  but  should  state  the 
amount  or  value  of  the  lease,  if  of  a  long 
term  and  valuable,  separately. 

If  the  building  is  leased  under  terms  by 
which  the  tenant  is  obliged  to  pay  for  all 
improvements,  any  large  outlay  may  be 
stated  in  the  balance  sheet  under  the  head- 
ing "Improvements,"  care  being  taken  to 
write  off  enough  annually  to  reduce  the 
amount  to  the  minimum  at  the  end  of  the 
lease. 

On  the  balance  sheet  of  the  Scarborough 
Manufacturing  Company  the  real  estate  is 
separated  into  two  accounts — "Land"  and 
"Buildings."  It  is  of  advantage  to  those 
who  examine  statements  to  have  these  items 
shown  separately.  When  this  is  done,  a 
better  idea  of  the  equipment  as  a  whole  and 
as  to  its  separate  parts  can  be  obtained  and 
a  better  estimate  of  the  amount  of  deprecia- 


90    Net  Worth  and  the  Balance  Sheet 

tion  can  be  calculated;  the  depreciation  on 
buildings  from  a  manufacturing  standpoint 
having  little  relation  to  the  rise  and  fall  in 
the  value  of  land. 

If  land  and  building  can  be  stated  sepa- 
rately, the  cost  of  each  should  be  shown, 
together  with  the  amount  of  depreciation  to 
the  date  of  making  the  statement.  The 
amount  of  depreciation  should  be  shown  as  a 
reserve.  The  assessed  value  of  the  real 
estate  and  the  market  value  should  also  be 
stated  in  a  footnote. 


CHAPTER   XIII 
MACHINERY — FIXTURES 

7l/fACHlNERY  as  applied  to  a  manufac- 
turing plant  means  all  plant  equipment 
owned,  other  than  buildings  and  land; 
engines,  boilers,  shafting,  belting,  genera- 
tors, machine  tools,  small  tools,  appliances, 
and  instruments;  such  machinery  or  me- 
chanical devices  as  are  used  in  the  operation 
of  the  mill  or  factory. 

Many  manufacturing  concerns  do  not  in- 
clude in  the  plant  inventory  small  tools  such 
as  hammers,  files,  saws,  chisels,  shovels,  and 
wheel-barrows.  Such  tools,  if  subject  to  con- 
stant use,  usually  wear  out  rapidly  and  fre- 
quent purchase  of  other  tools  is  required,  the 
cost  of  which  is  charged  to  the  expenses  of 
operation  and  not  to  the  plant  account. 

There  is  no  objection  to  this  plan,  nor,  on 
the  other  hand,  is  it  objectionable  to  include 
in  the  plant  inventory  and  carry  on  the  books 
all  small  tools  at  a  lump  sum  fairly  repre- 

91 


92    Net  Worth  and  the  Balance  Sheet 

senting  the  value  of  such  tools  as  are  re- 
quired to  be  on  hand  at  all  times.  The 
amount  of  the  ledger  account  need  not 
change  unless  the  number  and  value  of  the 
small  tools  change  materially.  Under  such 
circumstances  all  renewals  of  worn-out  tools 
may  properly  be  charged  to  maintenance  of 
the  plant  as  an  operating  expense. 

Valuation  of  Machinery 

The  valuation  of  machinery  shotdd  be 
based  upon  cost,  with  the  proper  deductions 
for  depreciation,  and,  if  buildings  are  not 
owned,  with  due  regard  for  the  terms  of 
lease. 

Appraisal  companies,  when  asked  to  ap- 
praise machinery,  usually  attempt  to  fix  a 
valuation  thereon  which  they  describe  as  the 
"reproduction"  value  at  the  time  the  ap- 
praisal is  made.  For  example,  if  a  machine 
was  purchased  many  years  ago  at  a  cost  of 
$1,000,  and  at  the  time  the  appraisal  was 
made  could  not  be  duplicated  as  a  new  ma- 
chine for  less  than  $1,200,  the  latter  amount 
would  be  used,  to  which  would  be  added  an 


Machinery — Fixtures  93 

estimated  amount  to  represent  cost  of  freight 
and  installation. 

From  the  "reproduction"  value  is  deducted 
the  estimated  amount  of  depreciation  on  the 
old  machine  as  it  stands  at  the  time  the  ap- 
praisal is  made.  If  carefully  estimated,  the 
total  of  the  inventory  and  appraisement  thus 
produced  represents  the  estimated  amount 
which  would  be  required  to  reproduce  the 
machinery  in  the  condition  found  at  the  time 
the  appraisal  was  made. 

If  the  amount  so  found  is  kept  in  a  sep- 
arate book  and  used  only  for  fire  insurance 
purposes,  the  method  is,  if  carefully  exe- 
cuted, reliable  enough  for  that  purpose.  If, 
however,  the  amount  so  found  is  placed  upon 
the  books,  it  sometimes  causes  a  "writing  up'' 
of  the  machinery  accounts  and  produces  a 
surplus  not  justified,  on  the  mere  assump- 
tion that  new  machinery  would  cost  more 
to-day  than  formerly. 

Wherever  possible,  it  is  safer  for  the  man- 
agement of  any  business  to  maintain  the 
machinery  account  at  cost,  providing  for  de- 
preciation by  proper  charges  to  the  operating 


94    Net  Worth  and  the  Balance  Sheet 

expenses  and  corresponding  credits  to  a  Re- 
serve for  Depreciation  account. 

There  can,  of  course,  be  no  argument 
against  the  conservative  adjustment  of  book 
values  according  to  established  facts,  but  if 
machinery  values  are  adjusted  and  read- 
justed according  to  the  opinion  of  successive 
appraisers,  an  unreliable  balance  in  the  ma- 
chinery account  is  likely  to  result.  Further- 
more, such  ups  and  downs  of  the  machinery 
account  may  produce  deceiving  effects  upon 
the  surplus  account. 

If,  on  the  other  hand,  the  original  cost  of 
machinery  is  adhered  to,  with  deductions  for 
worn-out  machinery  and  additions  for  new 
machinery,  the  balance  of  the  account  always 
means  something  definite.  It  means  that 
every  article  of  machinery  in  use  at  any 
given  time  is  represented  in  the  machinery 
account  at  its  original  cost.  The  offsetting 
account  where  the  wear  and  tear  of  the  ma- 
chinery is  provided  for  is,  of  course,  the  re- 
serve account,  which  will  be  more  fully  de- 
scribed in  its  own  chapter. 

Machinery  Inventory  should  not  include 


Machinery — Fixtures  95 

obsolete,  dismantled,  or  worn-out  tools  or 
appliances  at  higher  than  scrap  value. 

Sometimes  machinery  of  special  kinds  is 
purchased  to  be  paid  for  in  instalments.  If 
the  full  value  of  the  machine  is  stated  as  an 
asset,  the  amount  of  the  unpaid  instalments 
should  appear  in  the  liabilities. 

Where  buildings  are  not  owned,  a  careful 
inventory  of  machinery  actually  owned  by 
the  manufacturer  should  be  made,  and  a  defi- 
nite understanding  between  the  owner  and 
tenant  should  be  reached  as  to  just  what  may 
be  removed  by  the  tenant  as  his  property  at 
the  expiration  of  the  lease. 


CHAPTER   XIV 
FURNITURE  AND  FIXTURES 

pfURNITURE  and  Fixtures,  as  usually 
understood,  means  articles  of  ordinary 
or  special  use  needed  by  a  merchant  or  manu- 
facturer to  display  his  stock  of  goods  or 
samples,  afford  conveniences  to  his  custom- 
ers and  clerks,  and  record  his  business  trans- 
actions. 

Ordinarily  the  term  includes  many  articles, 
such  as,  for  example,  show-cases,  desks, 
racks,  shelves,  chairs,  typewriters,  and  some- 
times electric  lighting  systems,  sprinkler  sys- 
tems, partitions,  and  all  improvements  not 
forming  part  of  the  building  as  a  building. 

The  furniture  and  fixtures  should  be  val- 
ued at  cost  price,  less  a  proper  deduction  for 
depreciation. 

If  the  building  is  owned  by  the  merchant  or 
manufacturer,  Furniture  and  Fixtures  may 
include  all  the  various  articles  usually  so 
designated,  whether  separate  from  or  at- 

96 


Furniture  and  Fixtures  97 

tached  to  the  floors,  walls  or  ceilings,  such  as 
elevators,  and  sprinkling,  heating  and  light- 
ing systems;  but  if  the  building  is  not  owned 
by  the  merchant,  in  inventorying  and  valuing 
the  furniture  and  fixtures  due  regard  should 
be  given  to  the  terms  of  the  lease. 


CHAPTER   XV 
OTHER  ASSETS 

r"PHE  ordinary  statement  forms  provided 
by  banks  for  the  preparation  of  state- 
ments by  their  customers  are  usually  very 
much  condensed  and  provide  no  special 
spaces  for  assets,  save  those  which  have  been 
described.  Where  other  assets  are  to  be 
listed,  the  term  "Other  Assets"  is  frequently 
used  with  a  blank  space  or  two  for  the  sep- 
arate listing  of  important  items. 

In  a  business  of  ordinary  character,  the 
items  which  cannot  be  properly  placed  under 
any  of  the  more  specific  accounts  will  not  be 
numerous  or  important,  but  there  are  excep- 
tions to  this  general  rule.  In  such  excep- 
tional cases  all  the  important  assets  of  the 
business  should  be  listed  and  described  sep- 
arately. 

Horses,  wagons,  and  harness  may  be  of 
sufficient  importance  to  list  separately,  in 
which  case  the  amount  should  be  shown  at 

98 


Other  Assets  99 

cost  with  proper  deductions  for  depreciation, 
or  at  an  appraised  value. 

Funds  in  the  hands  of  foreign  banks  and 
investments  of  surplus  capital  in  stocks  and 
bonds  may  be  shown  under  this  general  head- 
ing, as  well  as  investments  of  sinking,  in- 
surance, or  other  special  funds. 

If  large,  each  of  these  separate  assets 
should  be  described  and  the  amount  shown. 

Investments  in  the  stocks  and  bonds  of 
subsidiary  or  affiliated  enterprises,  advances 
for  cash  to  such  enterprises,  or  charges  for 
goods  delivered  to  them,  should  be  listed 
here. 

Treasury  Stock 

Frequently  in  corporation  statements  an 
item  called  "Treasury  Stock"  appears  as  an 
asset.  In  some  cases  the  amount  represents 
an  asset  of  the  corporation.  This  is  so  when 
the  corporation,  having  issued  its  capital 
stock,  acquires  portions  of  it  for  resale.  In 
other  cases  the  so-called  Treasury  Stock  rep- 
resents merely  that  portion  of  the  authorized 
capital  stock  which  has  not  been  issued.  In 


100     Net  Worth  and  the  Balance  Sheet 

the  latter  class  of  cases  the  amount  of  such 
unissued  stock  is  erroneously  entered  at  par 
as  an  asset  and  the  total  authorized  capital  is 
entered  among  the  liabilities.  A  corporation 
is  liable  to  account  to  the  shareholders  for 
only  such  capital  as  has  been  contributed  by 
them,  and  therefore  the  real  capital  liability 
can  only  be  the  amount  of  shares  actually 
issued  and  for  which  payment  has  been  made. 
There  are,  as  stated,  cases  in  which  its 
own  stock  may  be  acquired  by  the  corpora- 
tion and  become  real  Treasury  Stock.  As 
a  rule,  capital  stock  may  be  issued  only  for 
money,  property,  or  services  rendered,  and  it 
can  only  be  issued  at  par  value  for  the  assets 
acquired  or  services  rendered.  After  it  is 
once  issued  to  shareholders  and  afterward 
lawfully  reacquired  by  the  corporation  by 
purchase  or  by  donation,  it  becomes  the  prop- 
erty of  the  company  and  may  be  sold  for  any 
price  above  or  below  par.  This  stock  is 
Treasury  Stock  in  the  proper  sense. 

Business  Investments 

Merchants  interested  in  producing  com- 


Other  Assets  101 

panics  will  frequently  hold  stock,  bonds,  or 
other  assets  of  various  kinds  in  the  concerns 
for  which  they  act  as  distributors.  As  an 
illustration,  many  wholesale  lumber  firms 
own  lumber  mills  at  points  distant  from  their 
own  yards  or  offices ;  also  timber  tracts  for  the 
purpose  of  acquiring  lumber  for  sale.  Care 
should  be  taken  to  describe  these  holdings, 
so  that  it  may  be  seen  just  what  interest  the 
firms  have  in  the  mills,  and  whether  the 
tracts  are  actually  owned  or  whether  the 
ownership  includes  merely  the  stumpage 
rights.  All  such  items  should  be  so  described 
that  the  exact  nature  of  the  right  or  title 
may  be  clearly  seen. 

Valuation  of  Patterns 

Under  the  head  of  "Other  Assets"  also 
fall  the  items  of  patterns,  patents,  trade- 
marks, good-will,  copyrights,  cost  of  secret 
processes,  formulae,  and  stereotypes,  the  val- 
uation of  all  of  which  requires  special 
thought  and  skill. 

The  first  of  these  assets,  patterns,  is  one 
the  valuation  of  which  has  caused  much  dis- 


cussion,  not  only  where  special  castings  are 
made  in  foundries  belonging  to  the  concern, 
the  castings  forming  one  stage  only  of  the 
process  of  manufacture,  but  as  well  in  foun- 
dries where  no  other  business  is  carried  on 
besides  the  manufacture  of  general  castings 
for  other  manufacturers. 

In  one  case  it  was  found  that  a  concern 
had  been  carrying  a  very  large  number  of  pat- 
terns at  full  cost  value  for  years,  although 
orders  for  but  few  of  the  castings  had  been 
received  during  that  time.  In  an  effort  to 
ascertain  the  probable  value  the  books  were 
examined  for  sales.  One  gear  wheel  pattern 
was  found  to  have  been  unused  for  over  two 
years,  while  six  of  the  wheel  castings  had 
remained  unsold  in  stock  during  all  of  that 
time. 

When  the  expense  of  making  patterns  has 
to  be  borne  by  the  foundryman,  it  is  hard 
for  him  to  make  up  his  mind  that  the  value 
of  patterns  is  very  little  if  the  customers  do 
not  repeat  their  orders  within  a  reasonable 
length  of  time.  What  is  a  reasonable  time 
depends,  of  course,  upon  the  circumstances 


Other  Assets  103 

in  each  case,  but  it  is  much  the  safer  policy 
to  write  off  the  cost  of  the  patterns  rapidly 
until  the  asset  value  of  such  of  them  as  are 
not  in  actual  use  is  reduced  to  a  nominal 
amount. 

In  some  lines  of  manufacture  where  large 
varieties  of  castings  are  required  to  produce 
the  articles  manufactured,  the  patterns  are 
valued  under  general  rules  more  or  less 
rigidly  followed  by  manufacturers  in  such 
lines.  A  rule  observed  by  some  manufac- 
turers is  that  patterns  shall  not  be  carried  on 
the  books  at  a  greater  value  than  an  amount 
equal  to  10  per  cent,  of  the  average  yearly 
sales  for  the  three  years  preceding  the  date 
of  valuation. 

Another  rule  calls  for  the  writing  down 
of  patterns  50  per  cent,  the  first  year  and 
25  per  cent,  the  second  year,  at  which  time 
an  appraisement  is  made  and  the  pattern  val- 
uation adjusted  on  the  books. 

Another  more  general  rule  calls  for  the 
establishment  of  an  arbitrary  lump  sum  at 
which  patterns  are  carried  on  the  books,  all 
expense  for  patterns  during  the  year  in  ex- 


104     Net  Worth  and  the  Balance  Sheet 

cess  of  that  amount  being  charged  off  at 
the  close  of  the  year. 

No  general  rule  adopted  by  others  may  be 
safely  followed  by  any  manufacturer.  The 
manager  of  each  foundry  and  each  factory 
of  every  kind  in  which  patterns  of  one  de- 
scription or  another  are  used  should  study 
the  problem  for  himself,  not  leaning  too 
strongly  in  favor  of  the  thought  that  some 
day  little-used  patterns  may  be  valuable ;  nor, 
on  the  other  hand,  leaning  too  much  the 
other  way  in  favor  of  reducing  the  value  to 
a  merely  nominal  sum.  Good  patterns  in  a 
going  business  possess  considerable  value, 
not  only  because  of  the  reduced  cost  of  re- 
peat orders  but,  in  addition,  because  the  time 
saved  in  reproduction  will  in  itself  attract 
customers,  who,  in  the  case  of  a  general 
foundry,  may  be  in  urgent  need  of  castings 
made  from  the  patterns,  or  in  the  case  of  a 
factory,  may  be  in  need  of  the  manufactured 
articles  of  which  the  castings  form  a  part. 

There  is  perhaps  no  better  way  to  arrive 
at  the  value  of  patterns  than  by  a  careful 
inventory  at  the  end  of  each  year,  and  an  ap- 


Other  Assets  105 

praisement.  This  should  be  made  by  those 
of  the  management  who  may  be  relied  upon 
to  be  conservative,  and  take  into  considera- 
tion all  of  the  conditions  of  the  business,  the 
part  which  each  pattern  plays  in  the  sales, 
and  the  prospects  of  future  orders. 

Valuation  of  Trade-Marks 

Trade-marks  and  brands  should  not  be 
placed  upon  the  books  as  assets  unless  pur- 
chased from  another  concern.  The  actual 
cost  of  obtaining  original  protection  of  such 
things  is  too  small  to  become  an  expressed 
asset  of  the  business.  Where  the  business 
has  been  incorporated  and  the  trade-marks 
or  brands  have  been  acquired  by  the  com- 
pany from  the  former  owners,  it  is  perfectly 
proper  for  the  new  owner  to  enter  these 
items  as  assets  on  the  books  at  the  purchase 
prices.  Afterwards,  serious  consideration 
should  be  given  at  each  closing  period  to  the 
book  valuation  as  compared  with  the  actual 
value. 

A  steel  specialty  manufacturer  has  spent 
considerably  over  $1,000,000  in  advertising 
his  trade-name  and  trade-mark,  and  there- 


106     Net  Worth  and  the  Balance  Sheet 

fore  carries  the  trade-mark  on  his  books  at 
this  valuation.  He  has  been  successful  and 
could  well  afford  to  diminish  this  amount  by 
writing  off  freely  from  it  each  year  for  sev- 
eral years  without  materially  reducing  his 
book  profits.  But  his  view  is  that  the  trade- 
mark is  worth  $1,000,000  and  should  so 
show  on  the  books.  In  this  case,  being  the 
principal  owner  of  a  wealthy  concern  and 
the  party  principally  interested,  no  one  can 
seriously  question  his  judgment.  If,  how- 
ever, the  amount  of  the  trade-mark  asset  was 
essential  in  his  statement  in  order  to  produce 
a  surplus  or  net  worth,  the  actual  value  would 
be  brought  into  serious  question  by  an  exam- 
iner for  credit  purposes,  or  by  any  one  veri- 
fying the  net  worth  of  the  business. 

In  the  case  referred  to  the  proprietor  is 
mistaking  the  value  of  his  trade-mark  for 
the  value  of  his  good-will,  taking  everything 
connected  with  it  into  consideration.  It  is 
very  doubtful  whether  any  one  would  pay 
$1,000,000  for  the  trade-mark  separate  from 
the  business,  its  organization,  plant,  and 
management. 


CHAPTER   XVI 
OTHER  ASSETS  (continued) 

"New  Business"  Cost 

EQUENTLY  when  manufacturing 
concerns  first  begin  their  operations  a 
large  amount  of  expense  must  be  undertaken 
in  introducing  their  products  before  the 
annual  profits  on  the  sales  amount  to  enough 
to  bear  the  expense  of  this  work.  Again, 
even  after  the  business  is  established,  new 
policies  of  expansion  may  be  adopted  and 
large  amounts  of  money  be  expended  in  ad- 
vertising, and  for  samples,  salaries,  and  ex- 
penses of  special  salesmen  and  representa- 
tives, before  any  adequate  returns  are  se- 
cured. 

It  is  quite  a  common  practice  among  man- 
ufacturers to  carry  such  expenses  along  in 
some  form  of  asset  account  until  the  de- 
veloped or  expanded  business  reaches  a  point 
where  the  expense  of  obtaining  new  business 
can  be  paid  out  of  the  profits. 

107 


This  outlay  is  sometimes  called  "Mission- 
ary Work"  or  "Introducing  Expense,"  and 
an  account  under  some  such  designation  may 
be  found  on  numerous  balance  sheets. 

The  real  asset  value  of  such  expenditures 
is  difficult  to  appraise.  The  utmost  con- 
servatism is  needed  if  they  are  to  be  consid- 
ered as  assets  at  all.  At  most,  such  expenses 
amount  to  deferred  charges  to  the  regular 
expense  account,  since  all  money  expended 
in  obtaining  business,  whether  new  or  old, 
must  be  charged  as  an  expense  of  the  busi- 
ness sooner  or  later. 

In  certain  cases  the  extraordinary  amounts 
over  and  above  ordinary  selling  expense 
spent  in  one  year  may  be  considered  as  the 
cost  of  obtaining  future  business  and  may  be 
spread  over  a  short  subsequent  period  in- 
stead of  being  charged  in  total  to  the  ex- 
pense of  the  year  in  which  the  money  is  ac- 
tually disbursed. 

Valuation  of  Good- Will 

This  discussion  leads  us  directly  to  the 
subject  of  good-will,  concerning  the  value  of 
which  opinions  differ  widely. 


Other  Assets  109 

An  intangible  asset,  good-will,  if  admitted 
to  be  an  asset  in  any  given  case,  may  be  of 
more  value  than  any  other  item  in  the  entire 
statement,  or,  on  the  other  hand,  it  may  be 
worthless.  For  this  reason  it  has  been  sug- 
gested that  it  should  not  appear  as  an  asset 
at  all. 

In  a  recent  case  the  question  of  the  value 
of  good-will  arose.  The  owner  proposed  the 
sum  of  $50,000  as  the  amount  which  he 
would  accept  for  the  good-will  of  the  busi- 
ness into  which  he  was  about  to  admit  a 
partner.  The  business  had  been  running 
steadily  behind  ever  since  it  was  started,  five 
years  before.  The  proprietor,  instead  of 
having  built  up  a  profitable  business,  had,  in 
reality,  been  able  to  hold  his  head  above 
water  only  by  means  of  the  capital  ad- 
vanced to  him  by  friendly  banks  and  indi- 
viduals. 

Now  in  law  we  say  that  good-will  is  the 
probability  that  old  customers  will  return  to 
the  new  proprietors,  the  assumption  being 
that  profits  on  business  brought  by  these  cus- 
tomers will  continue  without  the  exertion 


110     Net  Worth  and  the  Balance  Sheet 

originally  necessary  to  build  up  an  estab- 
lished profitable  business. 

What  good-will  can  there  be  in  a  losing 
business?  Either  the  customers  are  in- 
herently unprofitable,  or  the  articles  do  not 
possess  salable  merit  to  a  profitable  extent, 
or  perhaps  the  business,  while  possessing  in- 
herent merit,  has  been  conducted  so  care- 
lessly that  no  real  profit  can  exist  until  the 
management  is  changed.  If  this  last  con- 
dition be  found  to  exist  in  any  given  plant, 
what  amount  can  the  proprietor  claim  for 
his  good-will? 

He  may  have  many  friends  who  have  that 
good  will  toward  him  which  impels  them  to 
go  to  him  for  goods,  but  will  they  continue 
if  the  prices  are  raised  to  a  profitable  point 
or  if  the  management  is  changed? 

It  would  seem  that  when  a  man  claims  pay- 
ment for  the  good-will  of  his  business  he 
should  be  able  to  point  to  the  net  worth  as 
shown  by  his  books,  and  also  to  the  profit  he 
has  made  in  the  conduct  of  his  business 
through  increasing  numbers  of  satisfied  cus- 
tomers. He  should  be  able  to  say,  "Here  is 


Other  Assets  111 

my  business.  My  books  do  not  show  all  of 
my  assets.  I  have  built  up  a  successful  busi- 
ness, which  now  has  a  momentum  sufficient 
to  insure  profits  to  you  right  from  the  start. 
That,  gentlemen,  is  my  good-will." 

Good-will,  when  purchased  with  the  other 
assets  of  the  business,  ought,  according  to 
general  custom,  to  be  written  down  each 
year  until  it  has  entirely  disappeared  from 
the  books.  Good-will  is  an  asset  of  great 
value  when  a  successful  business  is  being 
sold,  but  as  a  part  of  a  business  man's  net 
worth  or  surplus  expressed  in  the  figures  on 
the  books  it  is  not  so  attractive  to  him  or 
to  any  one  else.  When  the  time  arrives  for 
selling  the  business  the  buyer  will  hardly  pay 
any  attention  to  the  amount  of  good-will  as 
expressed  in  the  assets.  His  judgment  will 
be  based  upon  a  thorough  examination  of  the 
nature  and  character  of  the  business,  its  vol- 
ume, its  customers,  and  its  profits,  and  he 
will  also  want  to  determine  from  every  point 
of  view  the  effect  the  staying  in  or  going  out 
of  the  old  proprietors  will  have  on  the  busi- 
ness. 


1 12    Net  Worth  and  the  Balance  Sheet 

Deferred  Assets 

Under  the  general  heading  of  "Other 
Assets"  on  a  balance  sheet  will  appear  also 
prepaid  items  of  expense,  such  as  insurance, 
taxes,  interest,  rent,  and  sundry  expenses, 
which,  in  a  finely  calculated  system  of  ac- 
counting, constitute  items  of  expense  actually 
paid  in  the  period  immediately  prior  to  the 
inventorying,  but  a  part  of  which  expense, 
ascertained  by  calculation,  justly  belongs  to 
the  following  period.  These  items  are  some- 
times classed  as  "Deferred  Assets"  or  "De- 
ferred Charges  to  Operation,"  the  meaning 
of  the  term  being  that  the  items,  while  not 
assets  in  the  ordinary  sense,  are  expenses 
paid  in  advance  and  not  expenses  of  the 
period  closed.  They  form  items  of  expense 
which  have  been  deferred  until  the  later 
period  of  accounting. 

Reserve  Fund  Investments 

In  the  specimen  balance  sheet  of  the  Scar- 
borough Manufacturing  Company  are  two 
accounts  indicating  that  the  company  holds 
securities  of  other  corporations  as  invest- 


Other  Assets  113 

ments.  Just  what  the  nature  of  these  invest- 
ments is  does  not  appear,  but  the  name  of 
one  of  the  accounts,  Reserve  Fund  Invest- 
ments, is  an  indication  that  whatever  the 
securities  may  be,  they  have  been  purchased 
in  pursuance  of  the  idea  of  actually  setting 
aside  and  investing  a  portion  at  least  of  the 
reserved  profits. 

Among  the  liabilities  will  be  found  Re- 
serves, $108,417,  consolidating  several  ac- 
counts on  the  books,  to  which  have  been 
credited  the  periodical  instalments  of  reserve 
taken  out  of  the  regular  profit  and  loss  ac- 
counts by  means  of  charges. 

An  analysis  of  the  Reserve  accounts  is 
given  in  the  chapter  on  Reserves,  where  it 
will  be  seen  that  a  part  of  the  amount  con- 
sists of  a  Sinking  Fund  Reserve.  Under 
the  terms  of  the  mortgage  given  as  collateral 
for  the  loan  shown  in  Bonded  Debt,  instal- 
ments of  $5,000  each  year  must  be  set  aside 
so  that  in  twenty  years  from  the  date  of  the 
loan,  when  it  is  due,  there  will  be  on  hand 
money  to  the  full  amount  of  the  loan  ready 
to  pay  it  off. 


114    Net  Worth  and  the  Balance  Sheet 

The  Scarborough  Manufacturing  Com- 
pany set  aside  the  instalments  for  five  years, 
and  invested  the  amount  in  first  mortgage 
bonds  of  several  railroad  companies.  The 
amount  paid  for  securities,  with  premium, 
was,  on  December  31st,  $22,626.79.  The 
treasurer  of  the  company  is  awaiting  a 
favorable  opportunity  to  invest  the  unin- 
vested portion  of  the  reserve. 

Other  Investments 

The  "Other  Investments"  on  the  balance 
sheet  represents  an  investment  of  $10,000  in 
some  small  tenements  rented  to  its  em- 
ployees, on  which  mortgages  had  been  placed 
prior  to  the  time  the  company  acquired  the 
property,  and  also  several  lots  of  stocks  of 
corporations  which  the  Scarborough  Manu- 
facturing Company  has  been  obliged  to  take 
in  part  satisfaction  of  accounts  due  them 
from  customers,  and  which  are  carried  at 
$7,428.72.  These  stocks  have  no  market 
value  and  their  actual  value  could  not  be  de- 
termined without  a  special  examination  of 
the  affairs  of  the  corporations  by  which  they 


Other  Assets  115 

are  issued.  No  dividends  have  been  paid  on 
these  stocks  for  a  number  of  years,  and  the 
probability  is  that  they  are  not  worth 
much. 


CHAPTER   XVII 
NOTES  PAYABLE 

TN  THE  Scarborough  Manufacturing 
•*•  Company  statement  provision  is  not  made 
for  a  separation  of  promissory  notes  given 
for  merchandise  purchased,  from  notes  given 
for  money  borrowed. 

In  many  balance  sheets  these  two  different 
classes  of  liabilities  are  shown  separately. 
We  will  first  discuss  Notes  Payable  for  Mer- 
chandise Purchased,  which  mean  unpaid 
promissory  notes  or  drafts  not  due,  given  in 
the  ordinary  course  of  business  for  mer- 
chandise, materials,  supplies,  or  other  articles 
used  in  the  business.  The  term  should  in- 
clude all  similar  notes  payable  negotiated  by 
branches,  or  agents  acting  for  the  merchant 
or  manufacturer. 

The  term  Bills  Payable  is  the  one  most 
commonly  used  to  designate  this  class  of 
commercial  paper,  and  as  so  used  it  has  a 
more  definite  meaning  to  the  courts  and  to 

116 


Notes  Payable  117 

lawyers  than  the  term  Notes  Payable.  It 
will,  however,  be  found  in  practical  experi- 
ence that  there  is  frequently  considerable 
confusion  in  statements  of  condition  between 
notes  given  to  merchandise  creditors  and 
bills  received  from  merchandise  creditors, 
the  term  Bills  Payable  being  applied  to  both. 
Some  merchants,  manufacturers,  and  bank- 
ers too,  think  of  a  Bill  Payable  as  being 
either  a  promissory  note  or  an  invoice  for 
merchandise.  While  no  lawyer  or  court 
would  misunderstand  the  use  of  the  term 
Notes  Payable,  many  merchants  and  manu- 
facturers would  misunderstand  the  use  of 
the  term  Bills  Payable,  so  that  it  seems  best 
to  use  the  one  term  which  will  be  best  under- 
stood by  all. 

Banks  sometimes  scrutinize  any  large  vol- 
ume of  notes  given  for  merchandise,  under 
the  belief  that  the  better  practice  for  business 
houses  to  pursue  is  to  borrow  money  from 
bank  and  pay  for  their  purchases  in  cash, 
taking  advantage  of  cash  discounts  offered. 
Banks  having  this  view  are  inclined  to  think 
that  notes  given  for  merchandise  purchased 


1 18    Net  Worth  and  the  Balance  Sheet 

indicate    inability   to   properly   finance    the 
business. 

Notes  Payable  for  Money  Borrowed 

Notes  Payable  for  Money  Borrowed  are 
unpaid  promissory  notes  or  drafts  not  due, 
given  for  money  borrowed  from  banks,  bank- 
ers, or  other  persons,  firms  or  corporations, 
for  use  in  the  business. 

Notes  payable  to  commercial  note  brokers, 
or  to  banks  through  them,  should  be  stated 
separately.  In  some  cases  the  relative  pro- 
portion between  the  loans  effected  through 
brokers  and  those  obtained  directly  from 
banks  indicates  conditions  which  would  not 
be  clear  if  the  two  accounts  were  consoli- 
dated under  the  general  head  "Notes  Pay- 
able for  Money  Borrowed." 

Some  large  concerns  can  best  finance  their 
operations  through  the  services  of  note  brok- 
ers in  conjunction  with  their  own  banks, 
while  others  can  be  accommodated  suffi- 
ciently through  their  own  banks  without  out- 
side assistance. 

But  some  smaller  concerns  mistake  the 


Notes  Payable  119 

position  in  which  note  brokers  are  most  use- 
ful and  go  to  them  to  the  neglect  of  their 
banks.  It  is  usually  much  wiser  for  all  busi- 
ness men  who  desire  to  secure  the  valuable 
services  of  note  brokers  to  do  so  with  the 
knowledge  and  acquiescence  of  their  banks. 


CHAPTER  XVIII 
ACCOUNTS  PAYABLE 

TN  THE  general  sense,  the  term  Accounts 
Payable  means  all  unsettled  credits  to 
parties  for  goods  purchased,  received,  and 
accepted;  also  credits  for  unpaid  salaries  or 
wages,  temporary  loans  and  other  unpaid 
obligations  to  creditors;  amounts  owed  by  a 
business  concern  to  others  as  shown  by  the 
books,  but  not  represented  by  promissory 
notes,  drafts,  bonds,  or  judgment  of  mort- 
gage. 

In  the  more  restricted  sense,  the  term  Ac- 
counts Payable  is  intended  to  represent  only 
unpaid  invoices  for  merchandise  purchased. 
It  includes  only  the  aggregate  of  unsettled 
credits  for  merchandise,  materials,  supplies, 
or  other  articles  purchased  for  sale,  either 
in  its  present  form  or  to  be  manufactured,  or 
for  use  in  the  business. 

In  the  ordinary  course  of  bookkeeping, 
credits  of  invoices  for  goods  received  and 

120 


Accounts  Payable  121 

accepted  are  entered  at  once  in  an  account 
with  the  creditor,  regardless  of  the  date  of 
payment  called  for  by  the  terms  of  the  pur- 
chase. Thus  any  general  total  of  Accounts 
Payable  will  not  disclose  whether  the  credits 
are  under-  or  overdue,  according  to  the  terms 
of  purchase.  In  order  that  a  more  intelli- 
gent understanding  of  the  business  may  be 
obtained,  it  is  desirable  that  the  accounts 
with  such  creditors  be  divided  into  "not  due" 
and  "overdue." 

Business  men  want  to  know  what  portion 
of  the  Accounts  Payable  is  falling  due  dur- 
ing the  next  week  and  month,  and  they  will 
want  to  know  at  the  same  time  what  part  of 
their  Accounts  Receivable  may  be  expected 
to  be  collected  in  time  to  take  care  of  those 
payments  as  they  mature. 

In  the  mind  of  the  careful  executive  it  is 
not  enough  for  him  to  know  that  the  cash 
balance  is  large  enough  to  meet  the  payments 
falling  due  during  the  next  few  days.  Be- 
yond this,  and  regardless  of  the  cash  balance 
at  any  time,  he  will  plan,  if  possible,  to  have 
the  collections  of  debts  due  his  concern  pro- 


122     Net  Worth  and  the  Balance  Sheet 

duce  the  funds  with  which  to  pay  all  concur- 
rent obligations. 

For  that  reason  it  is  clearer  to  him  if  a 
statement  is  prepared  showing  amounts  "not 
due"  and  "overdue"  on  both  sides  of  the  bal- 
ance sheet.  Of  course  he  will  want  much 
more  detailed  information  regarding  Ac- 
counts Receivable  and  Accounts  Payable 
than  can  be  incorporated  in  a  condensed 
statement,  but  even  if  they  are  only  classified 
into  "not  due"  and  "overdue,"  the  informa- 
tion is  valuable  and  enables  him  to  make 
searching  inquiries  should  "overdue"  appear 
in  connection  with  either  one  of  the  accounts. 
Explanations  may  satisfy  him,  but  he  will 
want  to  know  why  the  Accounts  Receivable 
are  not  collected  more  promptly  and  why  the 
overdue  merchandise  bills  for  purchases  by 
the  concern  have  not  been  settled  and  cash 
discounts  obtained. 

Care  should  be  taken  to  ascertain  that  all 
invoices  for  purchases  received  are  entered 
on  the  books  and  included  in  Accounts  Pay- 
able. If,  according  to  the  method  of  book- 
keeping employed  by  a  business  establish- 


Accounts  Payable  123 

ment,  any  such  invoices  are  omitted  from 
the  books  during  the  year,  the  amounts 
thereof  should  be  carefully  gathered  and 
stated  in  the  balance  sheet.  For  example, 
some  bookkeepers  file  bills  for  such  things  as 
office  supplies,  freight,  cartage,  and  other 
petty  expenses  without  making  any  entries 
concerning  them  on  the  books  until  paid, 
when  the  amounts  thereof  are  charged  to  the 
expense  accounts.  At  the  time  a  balance 
sheet  is  prepared,  many  such  bills  may  be 
found  on  the  file,  but  not  among  the  liabilities 
on  the  books.  Their  amount  should,  of 
course,  be  brought  into  the  balance  sheet. 


CHAPTER  XIX 
DEPOSITS 

"  [DEPOSITS"  in  the  sense  used  here 
mean  credits  for  money  deposited  for 
safe-keeping  or  in  trust  for  special  purposes, 
such  as  deposits  of  employees'  beneficial  or 
savings  funds. 

Among  large  manufacturing  corporations 
a  custom  is  growing  whereby  the  manage- 
ment encourages  the  employees  to  save  a 
small  proportion  at  least  of  their  wages. 
Those  of  the  employees  who  accept  the  plan 
consent  to  the  withholding  of  certain  agreed- 
upon  amounts  from  the  pay  envelopes,  which 
amounts  the  company's  officers  credit  on  the 
general  books  to  some  such  account  as  "De- 
posits of  Money  by  Employees,"  or  "Em- 
ployees' Savings  Fund,"  as  a  controlling  ac- 
count, the  detailed  account  with  each  em- 
ployee being  recorded  in  separate  or  sub- 
sidiary books. 

There  are  several  varieties  of  these  de- 

124 


Deposits  125 

posit  arrangements,  in  some  of  which  inter- 
est is  allowed  by  the  company,  and  to  which 
the  company  contributes  regular  amounts, 
either  voluntarily  each  time  the  contribu- 
tion is  made,  or  according  to  a  stipulated 
agreement  with  the  employees,  the  object 
being  to  encourage  them  to  accumulate  their 
savings. 

Another  phase  of  "Deposits"  is  found 
when  deposits  are  made  by  customers  of  a 
mercantile  concern  in  expectation  of  pur- 
chases at  its  stores,  the  amounts  of  any  such 
purchases  being  charged  to  these  deposit  ac- 
counts. Interest  is  allowed  on  the  average 
balance  of  such  deposits,  and,  in  addition,  an 
amount  is  credited  to  the  account  of  the  indi- 
vidual in  the  form  of  a  certain  percentage 
calculated  upon  the  aggregate  of  his  pur- 
chases during  the  year. 

Deposits  as  used  here  should  not  include 
any  loans  of  a  nature  calling  for  entry  in 
other  loan  liability  accounts,  nor  should  it  in- 
clude deferred  dividends  to  stockholders  or 
salaries  allowed  to  remain  in  the  business,  or 
loans  from  officers,  partners,  special  friends, 


126     Net  Worth  and  the  Balance  Sheet 

or  relatives,  intended  to  be  withdrawn  on  de- 
mand. 

In  order  to  give  a  clear  conception  of  the 
liabilities  of  the  merchant  or  manufacturer, 
such  loans  as  may  or  must  be  paid  prior  to 
the  other  creditors  on  open  account  should 
be  listed  separately  and  fully  described. 


CHAPTER   XX 
BONDED  DEBT 

"DONDED  DEBT"  as  used  in  financial 
statements  means  the  amount  of  money 
borrozved  upon  a  promise  to  pay  at  a  definite 
future  time,  with  real  or  personal  property 
mortgaged  as  collateral  security. 

Usually  the  mortgage  is  executed  in  favor 
of  a  trustee  for  the  bondholders,  and  bonds 
in  convenient  denominations  are  issued,  each 
one  of  which  describes  the  nature  and 
amount  of  the  debt  in  general  terms,  refer- 
ring to  the  mortgage  agreement  for  further 
information,  if  desired. 

Where  serial  bonds  are  issued,  secured  by 
a  mortgage  on  the  plant,  the  total  amount  of 
the  bonded  indebtedness  should  be  stated  "in 
short,"  with  a  deduction  of  the  amount  not 
issued,  so  that  the  amount  extended  in  the 
liability  column  will  represent  the  net  lia- 
bility. 

Ordinarily  bonded  indebtedness  is  secured 

127 


128     Net  Worth  and  the  Balance  Sheet 

by  a  mortgage  covering  all  of  the  real  estate 
used  in  the  business.  If  more  than  one  mort- 
gage or  lien  exists  on  the  whole  or  any  part 
of  the  real  estate,  it  would  form  a  clearer 
statement  of  the  actual  condition  of  the  mer- 
chant or  manufacturer  if  these  mortgages 
or  liens  were  separately  listed  and  described 
and  the  property  on  which  they  form  a  lien 
briefly  designated. 

Where  unsold  bonds  of  a  corporation  are 
delivered  as  collateral  for  loans  obtained,  a 
notation  of  the  amount  thereof  should  be 
made  in  short  under  this  heading,  or  in  a  foot- 
note at  the  bottom  of  the  statement. 

There  are  various  kinds  of  bonds  denot- 
ing the  lien  on  the  property  bonded,  such  as 
First  Mortgage,  Second  Mortgage,  General 
Mortgage,  Refunding,  etc. 

There  are  also  Income  Bonds,  issued  bvy  a 
corporation,  the  interest  on  which  is  payable 
only  out  of  the  income  of  the  corporation. 

Bonds  may  be  registered  with  the  income 
payable  to  the  registered  holder,  or  they  may 
be  registered  as  to  principal  only  with  cou- 
pons payable  to  bearer,  or  they  may  be  pay- 


Bonded  Debt  129 

able  to  bearer  both  as  to  principal  and  in- 
terest. 

Another  term  applied  to  a  form  of  securi- 
ties is  "Debentures,"  which  is  an  English 
term  meaning  bond.  While  a  debenture  may 
be  secured  by  a  mortgage,  it  does  not  neces- 
sarily include  the  idea  of  a  mortgage.  The 
security  may  rest  in  a  charge  on  definite  or 
indefinite  property,  while  a  regular  bond  and 
mortgage  always  constitutes  a  transfer  of 
the  real  estate  covered,  the  transfer  to  be  de- 
feated only  upon  payment  of  the  principal 
and  interest. 

A  form  of  debenture  sometimes  arises 
after  a  mortgage  has  been  placed  on  a  manu- 
facturing plant  and  the  bonds  secured  by 
the  mortgage  do  not  sell  as  readily  as  ex- 
pected. Banks  may  be  willing  to  loan  tem- 
porary funds  on  the  promissory  note  or  de- 
benture of  the  company,  with  the  bonds  de- 
posited with  a  trustee  as  collateral  security, 
when  they  would  not  purchase  the  bonds  out- 
right. 


CHAPTER   XXI 
MORTGAGES 

TITE  HAVE  just  discussed  Bonded  In- 
debtedness. In  the  case  of  most  large 
industrial  corporations  the  bonds  issued  for 
capital  obtained  consist  of  serial  denomina- 
tional bonds  secured  by  one  mortgage  placed 
upon  the  corporation's  property  for  the  se- 
curity of  all  bondholders.  In  other  cases, 
particularly  of  the  smaller  concerns,  the  reg- 
ular serial  bond  does  not  appear,  but  instead 
the  loan  is  obtained  by  the  owners  on  the  con- 
cern's single  bond  with  a  mortgage  on  the 
real  estate  as  collateral,  the  mortgage  being 
executed  in  favor  of  the  individual  firm  or 
corporation  loaning  the  money.  In  this  class 
of  loans  it  is  usual  to  describe  the  form  as 
that  of  a  loan  on  mortgage,  a  term  which  in 
this  sense,  as  a  liability,  means 

Mortgages  or  other  Hens  on  real  estate; 
money  borrowed  with  the  real  estate  of  the 
business  described  in  the  mortgage  pledged 
as  security  for  payment. 

130 


Mortgages  131 

In  many  statements  the  real  estate  and 
machinery  forming  the  plant,  if  mortgaged, 
are  carried  at  an  amount  equalling  the  differ- 
ence between  the  full  value  and  the  amount 
of  mortgage.  This  difference  is  usually 
styled  the  "equity"  in  the  property.  But  this 
does  not  give  a  just  presentation,  for  besides 
the  lien  given  on  the  property,  the  mortgagor 
assumes  personal  responsibility  to  pay  the 
full  amount  borrowed  in  case  the  debt  is  not 
paid  when  due  and  the  mortgaged  property 
does  not  produce  enough  money  to  satisfy 
the  debt.  If  the  sale  of  the  real  estate  does 
not  satisfy  the  amount  of  the  mortgage,  the 
mortgagee  can  collect  his  debt  out  of  other 
assets  of  the  business.  For  this  reason,  if 
for  no  other,  the  liability  to  pay  the  debt 
should  appear  on  the  books  as  a  liability  and 
the  full  amount  of  the  real  estate  and  ma- 
chinery as  an  asset. 

The  amount  of  the  mortgages  on  the  bal- 
ance sheet  should  also  include  any  mortgage 
liability,  subject  to  which  the  property  was 
acquired  by  the  present  owner.  When  prop- 
erty is  thus  taken  over  by  the  merchant  or 


132     Net  Worth  and  the  Balance  Sheet 

manufacturer  subject  to  a  mortgage  pre- 
viously placed  on  it,  the  purchaser  does  not 
under  ordinary  circumstances  assume  any 
personal  liability  to  pay  the  mortgage. 

In  such  case  the  rule  stated  above,  that 
every  mortgage  should  show  on  the  books  as 
a  liability,  might  not  seem  to  apply,  but  the 
desire  to  present  a  complete  statement  would 
still  impel  one  preparing  it  to  set  out  the 
full  mortgage  liability  of  the  concern. 

In  making  up  an  ordinary  statement  the 
question  of  priority  of  liens  does  not  arise. 
It  is  only  necessary  to  show  the  full  amount 
of  the  real  estate  as  an  asset  and  the  amount 
of  liability  in  the  form  of  liens  against  it. 
It  would  be  very  difficult  to  prepare  the  ordi- 
nary balance  sheet  of  a  merchant  or  a  manu- 
facturer so  that  it  would  exactly  express  the 
relation  between  the  various  classes  of  his 
secured  and  unsecured  creditors  so  that  his 
full  and  complete  legal  relation  to  each  and 
all  would  be  indicated. 

If  real  estate  other  than  that  used  in  the 
immediate  operation  of  his  business  is  owned 
by  the  merchant  or  manufacturer,  the 


Mortgages  133 

amount  of  such  real  estate  should  be  stated 
as  an  asset  separately  from  the  amounts  of 
real  estate  used  in  the  business.  Likewise, 
where  mortgages  or  other  liens  exist  against 
this  separate  property,  such  mortgages  or 
liens  should  be  stated  in  the  liabilities  sep- 
arately from  the  mortgages  or  liens  on  the 
real  estate  used  in  the  business. 
For  example,  there  might  appear 

In  the  Assets — 

Land  and  Building  in  Plant. . .  $200,000 
Property,  I5th  Street 10,000 

And  in  the  Liabilities — 

Mortgage  on  Plant 50,000 

Mortgage  on  I5th  St.  Property         2,000 

In  order  to  carry  out  the  idea  of  fully  ex- 
pressing assets  and  liabilities  on  the  balance 
sheet,  it  is  desirable  that  the  full  value  of 
land  owned  subject  to  an  annual  ground  rent 
be  carried  as  an  asset  and  the  capitalized  lien 
of  the  ground  rent  be  entered  as  a  liability. 

In  short,  the  balance  sheet  should  include 
the  amount  of  all  instruments  recorded  or 
unrecorded,  which  are  or  which  may  become 
when  recorded  a  lien  on  the  real  estate. 


CHAPTER   XXII 
OTHER  LIABILITIES 

IN  THE  usual  balance  sheet  form  provided 
by  banks  for  the  use  of  customers  there 
rarely  appear  separately  listed  liabilities 
other  than  those  which  have  been  described. 
In  ordinary  cases  all  liabilities  of  the  mer- 
chant or  manufacturer  are  shown  in  these 
accounts,  except  such  small  incidental  ex- 
penses as  are  commonly  omitted  from  even 
carefully  calculated  statements  of  condition. 
Sometimes,  however — and  frequently  in 
some  lines  of  business — items  not  found  in 
the  accounts  described  in  the  foregoing  chap- 
ters must  be  entered  in  the  balance  sheet.  To 
provide  for  such  items  the  term  "Other  Lia- 
bilities" is  frequently  printed  at  the  bottom 
of  the  statement,  with  a  blank  space  or  two 
for  separate  classes  of  items. 

Sometimes  under  this  heading  appear  ac- 
counts showing  the  amount  of  dividends  de- 
clared but  not  yet  paid,  unpaid  legal  fees, 

134 


Other  Liabilities  135 

insurance,  rent,  taxes,  interest  on  ordinary 
loans  and  on  bonded  debt,  royalties,  and 
commissions,  which  items  may  or  may  not 
show  under  the  heading  of  Accounts  Pay- 
able, according  to  the  method  of  bookkeeping 
employed. 

In  many  cases  when  an  analysis  is  made 
of  the  lumped  accounts  described  as  "Other 
Liabilities,"  items  are  found  which  materi- 
ally alter  the  impression  produced  by  an  in- 
spection of  the  statement  before  such  anal- 
ysis is  made. 

Accrued  Liabilities 

In  addition  to  the  unpaid  items  due  at  the 
time  of  the  preparation  of  a  statement,  and 
any  items  which  though  not  due  have  been 
passed  through  the  books  into  Accounts  Pay- 
able, there  may  be  other  items  for  salaries 
and  wages,  insurance,  rent,  taxes,  or  interest, 
which,  though  constituting  liabilities  to  the 
amount  accrued  to  the  time  the  statement  is 
made,  may  not  be  actually  due  for  payment 
until  some  time  later.  In  order  that  the  full 
liability  of  the  concern  may  be  shown,  a  care- 


136     Net  Worth  and  the  Balance  Sheet 

ful  calculation  should  be  made  of  the  pro- 
portion or  part  of  the  liability  accrued  on 
each  of  these  items  to  the  date  of  the  state- 
ment. 

For  example:  If  the  pay-roll  week  ends  on 
Thursday,  the  28th  of  the  month,  and  the 
fiscal  year  ends  on  the  30th  of  that  month, 
there  will  be  the  wages  of  the  plant  for  two 
days  to  take  into  consideration,  although  the 
next  pay  day  will  not  arrive  for  four  working 
days  after  the  end  of  the  fiscal  year.  The 
product  on  which  the  men  were  engaged  is 
taken  as  an  asset,  so  the  unpaid  wages  for 
the  two  days  should  be  stated  as  a  liability. 
Thus,  assuming  the  total  weekly  wage  roll  to 
be  $60,000,  the  accrued  wages  will  be 
$20,000. 

In  the  ordinary  business  concern,  if  the 
bookkeeping  is  well  managed,  the  amount  of 
accrued  items  should  not  be  large  enough  to 
materially  affect  the  net  worth  in  most  cases, 
the  accrued  assets  omitted  from  the  state- 
ment practically  offsetting  the  omitted  ac- 
crued liabilities. 

But  in  many  cases  the  addition  of  these 


Other  Liabilities  137 

accrued  items  will  throw  quite  a  different 
light  on  the  business,  especially  where  such 
items  are  large  and  are  paid  at  infrequent 
intervals.  If,  for  example,  the  taxes  of  all 
kinds  amount  to  a  considerable  sum,  and  are 
paid  but  once  each  year  at  about  the  same 
time,  the  amount  of  accrued  taxes  just  prior 
to  the  payment  would  be  a  material  item. 
But  under  a  good  system  of  bookkeeping  the 
amount  of  these  taxes  is  spread  over  the 
expenses  of  the  year  in  monthly  instalments, 
which  appear  on  the  books  as  a  liability  be- 
fore the  actual  payment,  or,  if  taxes  are  paid 
in  advance,  their  amount  is  distributed  in  the 
same  manner,  so  that  the  actual  cash  pay- 
ment, while  depleting  the  cash  balance  to  that 
extent,  does  not  disturb  the  net  worth  of  the 
concern. 


CHAPTER   XXIII 
CAPITAL  AND  CAPITAL  STOCK 

npHE  excess  of  assets  over  liabilities  con- 
*•  stitutes  the  net  worth  or  capital  of  an 
individual,  firm,  or  corporation  for  whose 
statement  of  financial  condition  the  balance 
sheet  is  prepared.  In  the  economic  sense  of 
the  word,  capital  means  wealth,  and  in  that 
sense  all  of  the  assets  to  which  the  possessor 
has  legal  title  constitute  his  wealth  or  capital, 
regardless  of  his  unpaid  debts,  even  though 
these  may  have  been  incurred  in  the  purchase 
of  some  or  all  of  those  assets. 

In  the  business  sense,  however,  capital 
means  the  amount  of  one's  own  capital  or  in- 
terest in  the  business  as  distinguished  from 
capital  borrowed  from  others,  either  directly 
as  a  loan  or  indirectly  by  means  of  purchases 
of  equipment,  material,  or  supplies  for  which 
payment  has  not  been  made.  Thus,  in  order 
to  find  the  net  capital  of  any  concern,  the 
liabilities  must  be  deducted  from  the  assets, 

138 


Capital  and  Capital  Stock         139 

the  remainder  constituting  the  capital  or  net 
worth  of  the  business. 

When  the  net  profits  of  an  individual  sole 
owner  of  a  business  are  ascertained,  the 
amount  is  usually  transferred  directly  to  his 
capital  account,  which  should  at  the  end  of 
every  closing  period  form  the  exact  balance 
between  his  assets  and  his  liabilities,  and  ex- 
hibit his  net  worth. 

In  the  case  of  a  partnership,  the  net  profits 
are  usually  divided  at  the  end  of  stated 
periods  according  to  the  terms  of  the  part- 
nership agreement,  and  the  amounts  so  de- 
termined are  credited  to  the  several  partners' 
accounts,  the  sum  of  these  accounts  forming 
the  capital  or  net  worth ;  provided,  both  as  to 
individuals  and  partnerships,  that  care  has 
been  taken  in  adjusting  the  book  value  of 
the  assets  to  agree  with  the  actual  value  as 
nearly  as  possible ;  and  provided  also  that  all 
of  the  assets  and  liabilities  are  placed  upon 
the  books. 

In  an  individual's  or  firm's  statement  the 
capital  will  be  shown  by  the  credit  balance  of 
the  individual's  or  partners'  capital  accounts, 


140    Net  Worth  and  the  Balance  Sheet 

a  capital  account  being  kept  in  the  name  of 
the  individual  owner,  or,  in  case  of  a  firm, 
in  the  name  of  each  and  all  of  the  partners. 

^•fc*. 

Capital  Stock 

In  a  corporation,  if  only  one  kind  of  stock 
is  issued,  the  capital  will  be  shown  in  the  sum 
of  the  Capital  Stock  account  on  the  ledger, 
or,  if  more  than  one  kind  of  stock  is  issued, 
then  in  accounts  for  all  classes  of  issues.  The 
capital  stock  should  be  entered  at  the  par 
value  of  the  shares  issued,  unless  these  are 
issued  when  only  part  of  their  par  value  is 
paid,  in  which  case  the  amount  paid  in  only 
should  be  credited  to  the  capital  account./fhe 
holdings  of  each  individual  are  shown  in  a 
subsidiary  book  called  the  "Shareholders' 
Ledger,"  the  aggregate  of  the  shares  credited 
to  the  individuals  agreeing  at  par  with  the 
amount  of  capital  stock  issued,  as  shown  in 
the  one  account  of  each  class  of  stock  on  the 
general  ledger. 

The  capital  stock  of  a  corporation  may  be 
divided  into  several  classes,  such  as  common, 
first  preferred,  second  preferred,  etc. 

There  are  other  kinds  of  stock  that  may  be 


Capital  and  Capital  Stock         141 

issued,  but  these  are  the  most  frequent.  In 
fact,  it  is  not  usual  for  manufacturing  or 
trading  corporations  to  issue  other  than 
"common  stock"  and  "preferred  stock." 

Until  comparatively  recent  years  the  entire 
capital  stock  of  a  corporation  consisted  of 
what  is  now  known  as  "common  stock,"  and 
it  was  issued  for  cash  or  for  property  ac- 
quired for  use  in  the  business.  Originally 
the  use  of  preferred  stock  was  generally  lim- 
ited to  cases  in  which  the  common  stock  had 
all  been  issued  and  additional  capital  was 
needed.  The  special  stock  was  then  issued  to 
those  who  would  furnish  the  capital. 

The  use  of  this  stock  is  not  now  limited  to 
special  purposes.  Such  stock  is  known  as 
"preferred"  stock  because  the  individuals  to 
whom  it  is  issued  possess  special  privileges 
or  "preferences"  not  possessed  by  the  com- 
mon or  ordinary  shareholders. 

In  some  cases  the  special  privileges  of  pre- 
ferred stock  consist  in  the  right  to  dividends 
at  a  stipulated  rate  before  the  common  share- 
holders can  receive  any  of  the  profits  of  the 
business. 


142     Net  Worth  and  the  Balance  Sheet 

An  additional  privilege  is  given  to  some 
of  the  issues  of  preferred  stock  described  as 
"cumulative  preferred,"  consisting  in  the 
right  to  receive  "back"  or  unpaid  dividends 
before  the  common  shareholders  can  receive 
dividends  in  case  the  corporation  fails  in  any 
one  or  more  years  to  earn  profits  to  a  suffi- 
cient extent  to  pay  the  current  stipulated 
dividend  on  the  preferred  stock. 

In  other  cases  the  preferred  stockholders 
are  not  only  preferred  as  to  dividends,  but  in 
addition  they  are  preferred  as  to  distribution 
of  assets  upon  dissolution  of  the  corporation 
after  liabilities  are  paid.  Some  of  the  pre- 
ferred stock  issues  possess  one  or  more  of 
these  special  privileges  and  some  possess  all ; 
the  special  preferences  over  ordinary  share- 
holders being  granted  to  make  the  preferred 
stock  more  attractive  to  purchasers. 

Formerly  when  preferred  stock  was  issued, 
it  was  intended,  as  a  rule,  to  call  it  in  and  pay 
the  shareholders  its  par  value  within  a  short 
time,  the  common  shareholders  being  left  in 
possession  of  their  full  rights  to  profits  and 
property.  This  idea  is  still  retained  in  some 


Capital  and  Capital  Stock          143 

issues  of  preferred  stock,  but  it  is  not  so  com- 
mon as  formerly. 

In  later  years  a  great  many  corporations 
have  been  formed  to  take  over  existing  prop- 
erties and  have  issued  preferred  stock  or 
bonds  for  the  cash  and  property  acquired, 
while  the  common  stock  has  either  been  given 
along  with  the  preferred  stocks  or  bonds  as 
a  bonus,  or  has  been  issued  for  the  supposed 
good-will  of  the  acquired  properties.  As  a 
result,  the  common  stock  has  degenerated 
into  a  condition  in  which  in  many  corpora- 
tions it  represents  very  little,  if  anything 
at  all,  when  first  issued. 

Capital  Stock  and  the  Property  Account 

In  inspecting  the  balance  sheet  of  a  cor- 
poration it  is  very  important  to  determine 
whether  all  of  the  stock  has  been  issued  for 
actual  property  or  whether  some  of  the 
amount  outstanding  represents  nothing  of 
any  tangible  value.  Frequently  we  find  in 
balance  sheets  a  condition  similar  to  the  fol- 
lowing: 


144     Net  Worth  and  the  Balance  Sheet 

NATIONAL  IRON  COMPANY 
Assets : 

Property  Account $4,552,339.00 

Investments 115,714.15 

Inventories 53°>I95-35 

Bills  and  Accounts  Receivable. .      235,555.00 

Cash 64,430.35 

Prepaid  Expense  Items 5>5°4-75 


Total   $5,503,738.60 


Liabilities : 

Preferred  Stock $2,500,000.00 

Common  Stock 2,500,000.00 

Bonds  and  Mortgages 20,000.00 

Accounts  and  Bills  Payable.  . .  .  164,282.25 

Accrued  Items 3,657.60 

Surplus 3I5.798-75 


Total  $5.503-738.60 


In  this  statement  it  will  be  seen  that  equal 
amounts  of  common  and  preferred  stock  have 
been  issued.  According  to  present  methods, 
the  natural  presumption  is  that  both  were 
issued  in  acquiring  the  plant  assets  which 
are  included  in  the  foregoing  statement 


Capital  and  Capital  Stock         145 

under  the  one  heading  "Property  Account" ; 
but  whether  the  actual  property  acquired  is 
worth  the  amount  at  which  it  is  carried  is 
not  disclosed  in  the  statement.  Property  ac- 
count in  this  case  may  represent  the  actual 
value  of  the  assets,  without  regard  to  the 
earning  power  or  good-will  of  the  business. 
But,  on  the  other  hand,  the  account  may  rep- 
resent, besides  the  actual  value  of  the  plant, 
the  par  value  of  stock,  both  preferred  and 
common,  given  in  excess  of  the  actual  value 
to  cover  the  good-will.  It  may  also  in  this 
case  contain  discount  on  preferred  stock  and 
other  items,  which  the  use  of  such  a  general 
term  as  "Property  Account"  properly  or  im- 
properly permits. 

It  may  be  that  the  bulk  of  the  preferred 
stock  was  issued  for  the  property,  the  re- 
mainder of  the  preferred  stock  being  issued 
for  cash  capital,  in  which  case  the  Property 
account  may  include  the  value  of  the  good- 
will, represented  by  the  amount  of  the  com- 
mon stock.  It  is  evident  that  a  large  part 
of  both  classes  of  stock  must  be  represented 
by  the  Property  account,  because  there  are 


146     Net  Worth  and  the  Balance  Sheet 

no  other  assets  large  enough  to  explain  their 
issuance. 

The  capital  stock  issued  amounts  to 
$5,000,000,  while  the  Property  account 
amounts  to  $4,552,339,  showing  that  the  bal- 
ance of  the  stock,  amounting  to  $447,661, 
was  probably  issued  for  other  assets.  It  may 
be,  of  course,  that  the  entire  issues  of  both 
classes  of  stock  were  given  in  payment  of  the 
property,  which  was  then  valued  at  $5,- 
000,000.  In  this  case,  since  the  Property  ac- 
count balance  is  less  than  the  par  value  of 
the  stock,  the  company  has  presumably  ap- 
plied its  earnings  to  the  reduction  of  the 
Property  account. 

Enough  has  been  suggested  as  to  the  possi- 
bilities in  this  case  to  show  that  the  use  of 
the  bulk  account  "Property  Account"  pre- 
vents the  observer  from  accurately  ascertain- 
ing the  true  condition  of  a  corporation  in 
whose  balance  sheet  the  item  is  found. 


CHAPTER   XXIV 
SURPLUS — PROFITS 

TN  THE  restricted  sense,  surplus  means 
accumulated  undivided  profits  arising 
from  the  operation  of  a  business. 

When  used  in  a  less  restricted  sense,  par- 
ticularly in  a  corporation  statement,  it  means 
the  excess  of  assets  over  liabilities  and  cap- 
ital. In  this  sense  surplus  may  include,  be- 
sides the  profits  of  the  business,  gains  arising 
from  acquisition  of  assets  other  than  those 
that  form  the  purpose  for  which  the  corpora- 
tion was  organised. 

An  example  of  surplus  under  the  less  re- 
stricted use  of  the  term  is  furnished  when 
stock  in  a  corporation  is  sold  to  subscribers  at 
a  fixed  amount  per  share  over  and  above  the 
par  value,  the  excess  providing  a  surplus  at 
the  beginning  of  existence  of  the  corporation. 
This  method  of  establishing  a  surplus  is  not 
often  used  by  other  than  financial  or  insur- 
ance institutions. 

147 


148     Net  Worth  and  the  Balance  Sheet 

Surplus  Not  from  Earnings 

An  example,  sometimes  found  in  ordinary 
manufacturing  corporations,  of  an  increase 
of  surplus  not  due  to  earnings  is  furnished 
when  subscribers  donate  to  the  corporation 
for  its  own  benefit  shares  of  capital  stock 
previously  purchased  by  them.  When  treas- 
ury stock  thus  acquired  without  cost  to  the 
company  is  placed  on  the  books  in  money 
value,  some  bookkeepers  credit  a  correspond- 
ing amount  to  the  Surplus  account.  To  the 
ordinary  observer  this  gives  the  false  im- 
pression that  the  Surplus  account  shown  on 
the  balance  sheet  has  been  earned  by  the  com- 
pany from  the  operation  of  the  business. 

Some  accountants  place  the  amount  so  ob- 
tained to  the  credit  of  an  account  called 
"Working  Capital"  or  "Capital  Surplus,"  in 
order  to  distinguish  the  book  surplus  so  ac- 
quired from  the  earned  surplus. 

Another  case  of  increased  surplus  not  due 
to  earnings  is  sometimes  found  when  a  busi- 
ness owned  by  an  individual  or  partnership 
is  sold  to  a  corporation,  the  payment  being 
made  in  capital  stock  of  the  company.  If  the 


Surplus — Profits  149 

amount  of  stock  issued  at  par  is  less  than  the 
book  value  of  the  net  assets  taken  over  and 
the  amounts  of  the  assets  are  transferred  to 
the  books  of  the  corporation  without  deduc- 
tions, a  surplus  of  book  assets  over  liabili- 
ties will  be  created  which  the  bookkeeper  will 
probably  credit  to  Surplus  account. 

If  the  net  assets  are  worth  the  amount  at 
which  they  were  entered  on  the  new  books, 
of  course  the  surplus  so  constituted  is  a  real 
surplus,  although  not  earned  by  the  new  com- 
pany ;  and  nothing  further  need  be  said,  save 
that,  when  subsequent  balance  sheets  of  the 
new  corporation  are  prepared,  a  clearer  state- 
ment of  condition  is  presented  if  the  surplus 
acquired  from  the  old  business  is  shown  sep- 
arately from  the  surplus  or  accumulated 
profits  earned  by  the  new  corporation. 

But  in  some  cases  the  assets  of  the  old  con- 
cern are  not  worth  their  book  value,  and  the 
apparent  surplus  is  no  real  surplus  at  all. 
In  such  cases  the  Surplus  account  may  be 
misleading  to  any  one  inspecting  statements 
of  the  corporation,  because  the  natural  pre- 
sumption is  that  the  Surplus  account  repre- 


150    Net  Worth  and  the  Balance  Sheet 

sents  profits  earned,  and  indicates  the  ability 
of  the  company  to  build  up  not  only  a  success- 
ful dividend-paying  business,  but  as  well  to 
provide  a  reserve  against  future  needs.  In- 
quiry should  always  be  made  concerning  the 
Surplus  account  in  order  that  it  may  be  made 
clear  just  what  part  of  it  has  been  earned 
and  what  part  has  been  built  up  by  other 
means. 

Accounts  in  Which  Surplus  May  Appear 

If  the  excess  of  assets  of  a  corporation 
over  liabilities  equals  the  capital,  there  is  no 
surplus,  in  the  general  sense,  the  capital  just 
balancing  the  excess  or  net  worth  of  the  busi- 
ness, but  if  there  is  an  excess  of  assets  over 
liabilities  and  capital,  there  is  a  surplus, 
and  while  it  may  not  be  shown  under  that 
name,  it  is  there.  It  may  appear  in  a  busi- 
ness statement  as  Profit  and  Loss,  Earnings, 
or  Undivided  Profits,  or  be  shown  in  part 
by  a  surplus  account  representing  accumu- 
lated profits  earned  prior  to  the  current 
year  and  in  part  by  a  profit  and  loss  account 
representing  only  the  balance  of  profits  of 


Surplus — Profits  151 

the  current  year  after  all  expenses  are  paid 
and  dividends  disbursed. 

When  any  classification  of  the  surplus  is 
shown  in  the  statement,  a  good  arrangement 
is  as  follows: 

(a)  Surplus — representing    accumulated 
undivided  profit  to  the  beginning  of  the  cur- 
rent fiscal  year. 

(b)  Profit   and   Loss — representing   the 
net  profits  for  the  current  fiscal  year. 

(c)  Special    Surplus — book   surplus    de- 
rived from  sources  other  than  actual  earn- 
ings. 

The  surplus  account  is  not  commonly 
found  on  the  books  of  individuals  and  firms, 
the  profits  being  accumulated  in  the  owners' 
capital  accounts  in  the  manner  already  de- 
scribed. 

In  one  sense,  the  surplus  of  a  business 
means  the  excess  of  assets  over  liabilities, 
and  it  is  sometimes  called  "Surplus  Assets." 
In  the  case  of  individuals  and  firms,  surplus 
means  the  same  thing  as  capital  or  net 
worth. 


152     Net  Worth  and  the  Balance  Sheet 

The  Corporate  Surplus 

In  corporation  accounting  more  formality 
is  required  than  in  that  of  firms  or  individ- 
ual owners,  and  the  usual  procedure  when  a 
balance  sheet  is  taken  calls  for  the  finding  of 
the  net  profits  for  the  year  and  then  for  the 
determination  of  how  those  profits  shall  be 
appropriated,  including  the  amount  to  be  dis- 
tributed in  the  form  of  dividends  to  the 
shareholders.  After  the  deductions  for  ex- 
traordinary expenses,  investments,  etc.,  are 
all  made,  the  net  amount  is  usually  trans- 
ferred to  the  Surplus  account,  where  it  re- 
mains as  a  fund  which  may  be  drawn  upon 
to  meet  extraordinary  occurrences  or  for 
payment  of  dividends  in  years  when  the  net 
profits  are  not  sufficient  in  themselves  to 
pay  the  customary  or  desired  dividends  to 
stockholders. 

As  will  be  seen,  the  term  "Surplus,"  when 
used  in  corporation  accounting,  does  not 
merely  indicate  the  excess  of  assets  over  lia- 
bilities, but  is  used  to  show  the  excess  of 
assets  over  both  liabilities  and  the  contrib- 
uted capital  as  represented  by  the  shares  of 


Surplus — Profits  153 

stock  issued.    This  is  shown  in  the  following: 

o 

illustration : 

Assets $500,000 

Liabilities 250,000 


Net  Worth $250,000 

Capital  Stock 200,000 


Surplus $50,000 

or  put  in  the  ordinary  balance  sheet  form: 
Total  Assets.  .$500,000    Total  Liabilities$25O,ooo 

Surplus 50,000 

Capital  Stock.. .  200,000 


$500,000  $500,000 

This  use  of  the  term  surplus  does  not 
at  all  affect  the  idea  of  net  worth,  which 
means,  in  each  and  every  case,  the  excess  of 
the  actual  value  of  the  assets  over  the  total 
of  all  the  liabilities  at  the  time  the  calcula- 
tion is  made,  regardless  of  the  capital  con- 
tributed originally  or  the  amount  of  the  cap- 
ital stock  issued  and  outstanding. 

Thus  in  the  foregoing  example  the  net 
worth  is  $250,000,  divided  into 

Capital  Stock $200,000 

Surplus 50,000 


154    Net  Worth  and  the  Balance  Sheet 

Corporate  Liability  for  Surplus 

The  corporation,  as  a  separate  entity  from 
the  shareholders  as  individual  contributors, 
is  certainly  answerable  to  the  shareholders 
not  only  for  the  money  contributed,  but  as 
well  for  the  amount  of  surplus  or  accumu- 
lated profits  not  previously  distributed  to 
them  in  the  form  of  dividends. 

This  liability  of  the  corporation  to  its 
shareholders  is,  however,  of  a  different  na- 
ture from  that  of  its  liability  to  its  outside 
creditors,  for  while  it  must  ultimately  ac- 
count to  the  shareholders  for  the  amounts 
of  their  contributions  and  profits,  its  accounts 
with  creditors  must  first  be  settled.  If  the 
corporation  is  liquidated,  and  after  settle- 
ment with  all  creditors  a  balance  of  assets  is 
found  to  be  in  hand,  the  shareholders  are 
entitled  to  a  distribution  of  those  assets  pro 
rata  according  to  the  number  of  shares  held 
by  each,  taking  into  account,  of  course,  the 
prior  rights  of  the  preferred  shareholders,  if 
any.  If  the  balance  of  assets  so  distributed 
equals  or  more  than  equals  the  amount  of 
the  shareholders'  contributions,  well  and 


Surplus — Profits  155 

goo'd;  but  if  the  settlement  with  creditors 
leaves  a  balance  of  assets  too  small  to  repay 
the  shareholders,  they  must  suffer  whatever 
loss  they  sustain  without  complaining,  unless, 
indeed,  some  action  may  be  taken  by  the 
shareholders  against  the  officers  and  direct- 
ors for  the  mismanagement  that  has  pro- 
duced the  unfortunate  or  criminal  condition. 
But,  except  in  cases  where  the  mismanage- 
ment is  such  that  the  law  will  compel  those 
in  charge  of  the  affairs  of  the  corporation 
to  reimburse  the  shareholders,  they  have  no 
redress  for  their  losses.  Hence  the  state- 
ment that  the  liability  of  a  corporation  to  ac- 
count to  the  shareholders  is  not  a  liability  in 
the  usual  meaning  of  the  term. 

Corporate  Deficit 

Sometimes  we  find  in  balance  sheets  this 
condition : 

Assets  $450,000     Liabilities $300,000 

Deficit 50,000    Capital 200,000 

Total .$500,000         Total .$500,000 

which  means  that  while  the  net  worth  of  the 


156    Net  Worth  and  the  Balance  Sheet 

concern  is  $150,000,  its  capital  has  been  im- 
paired to  the  extent  of  $50,000.  The  surplus 
not  only  does  not  exist,  but  in  its  stead  there 
is  a  deficit,  or  shrinkage  in  the  actual  book 
value  of  the  capital  stock. 

Stated    in    another    way,    the    condition 
would  be : 

Assets $450,000 

Liabilities  300,000 


Net  Worth $150,000 


Capital  Stock $200,000 

Less  Impairment 50,000 

$150,000 


In  whatever  form  the  surplus  appears  on 
a  balance  sheet,  inquiry  should  be  made  as 
to  its  source,  and  an  analysis  of  this  account 
for  a  period  of  not  less  than  five  years  imme- 
diately preceding  the  date  of  the  balance 
sheet  will  throw  much  light  upon  the  condi- 
tion of  the  concern  whose  net  forward  or 
backward  movement  it  represents. 


CHAPTER   XXV 
RESERVES 

T3ESERVE  accounts  consist  of  charges 
•*•*'  against  the  earnings  of  the  business 
transferred  to  these  accounts  as  credits,  for 
the  purpose  of  offsetting  shrinkages  in  asset 
values.  The  most  common  of  these  reserve 
accounts  are  ordinarily  designated  as  "Re- 
serve for  Bad  and  Doubtful  Debts,"  and 
"Reserve  for  Depreciation  of  Plant."  In 
some  cases  an  account  representing  the  same 
thing  appears  as  "Contingencies  Account" 
or  "Reserve  for  Contingencies." 

In  the  ordinary  form  of  balance  sheet  the 
total  of  the  debit  balances,  or  assets,  is  shown 
at  the  foot  of  one  column  and  the  total  of 
the  credit  balances — including  capital,  sur- 
plus, and  reserves — is  shown  at  the  foot  of 
the  other  column.  Of  course  such  items  as 
reserves  are  not  liabilities,  but  they  are 
placed  in  the  liability  column  to  offset  the 
book  values  of  the  assets.  In  other  words, 

157 


158    Net  Worth  and  the  Balance  Sheet 

when  the  assets  are  listed  in  the  statement  at 
the  full  cost  value,  reserve  accounts  should 
be  shown  under  the  head  of  liabilities. 

Reserve  for  Bad  and  Doubtful  Debts 

Reference  has  been  made  to  the  care  which 
must  be  exercised  in  valuing  open  accounts 
due  from  customers.  After  all  accounts 
known  to  be  worthless  are  eliminated  and 
the  remainder  seem  perfectly  good,  there  is 
still  some  probability  that  the  actual  cash 
to  be  realized  in  the  collection  of  the  accounts 
will  fall  short  of  the  full  face  value  thereof. 
It  is  rarely  that  accounts  representing  several 
thousands  of  customers  and  aggregating 
hundreds  of  thousands  of  dollars  will  each 
and  every  one  be  settled  without  loss  or  ex- 
pense for  collection. 

For  this  reason  an  amount  calculated  as  a 
certain  percentage  of  the  total  of  sales,  based 
upon  past  experience,  should  be  set  aside  out 
of  the  profit  as  a  reserve  to  provide  against 
shrinkages  of  this  kind  which  would  other- 
wise render  the  statement  of  the  concern's 
net  worth  misleading. 


Reserves  159 

The  amount  so  set  aside  becomes  an  esti- 
mated loss  for  bad  and  doubtful  debts, 
though  these  debts  are  not  known  to  be  bad 
or  doubtful  at  the  time  the  statement  is  made. 
The  amount  set  aside  is  placed  to  the  credit 
of  the  reserve  account.  Sometimes  the  cor- 
responding debit  is  charged  direct  to  Profit 
and  Loss  account,  but  more  often,  and  partic- 
ularly in  bookkeeping  systems  where  it  is 
desired  to  show  the  full  operating  expenses, 
the  amount  is  charged  to  some  one  of  the 
operating  expense  accounts,  the  credit  of 
course  being,  as  before,  to  "Reserve  for  Bad 
and  Doubtful  Debts." 

During  the  year,  if  the  amounts  of  all  cus- 
tomers' balances  actually  found  to  be  worth- 
less are  charged  off — i.e.,  credited  to  the  cus- 
tomers' accounts  and  entered  as  debits  to  the 
Reserve  for  Bad  and  Doubtful  Debts — and 
all  the  other  accounts  open  at  the  beginning 
of  the  year  have  been  collected,  the  balance 
of  the  reserve  account  will  show  how  closely 
the  real  shrinkage  has  been  approximated. 
If  the  account  shows  a  credit  balance  re- 
maining over  and  above  the  total  amount 


160     Net  Worth  and  the  Balance  Sheet 

charged  against  it,  the  excess  of  credit  will 
indicate  the  amount  by  which  the  bad  debts 
were  overestimated.  If,  on  the  other  hand, 
the  charges  or  debits  for  bad  debts  exceed 
the  amount  credited  as  a  reserve,  this  indi- 
cates that  the  amount  of  the  bad  debts  was 
greater  than  anticipated,  and  a  larger  amount 
should  be  reserved  for  the  next  year. 

Reserve  for  Depreciation  of  Plant 

Sometimes,  on  books  of  large  manufactur- 
ing corporations,  there  are  several  accounts 
showing  reserved  profits  set  aside  to  guard 
against  overvaluation  of  assets,  but  more 
often  one  general  account  is  used  to  include 
all  depreciation  credits  for  the  buildings,  ma- 
chinery, and  miscellaneous  articles  of  equip- 
ment constituting  the  plant. 

In  some  cases  the  amount  of  depreciation 
is  roughly  estimated,  while  in  other  cases  the 
amount  is  carefully  calculated  after  consid- 
erable investigation  and  consultation  with 
the  superintendent  and  foremen  of  the  vari- 
ous departments,  or  with  outside  experts. 

In  some  systems  of  bookkeeping,  besides 


Reserves  161 

the  general  ledger  showing  the  plant  assets 
in  two  or  three  general  accounts,  a  separate 
plant  ledger  is  regularly  kept,  in  which  de- 
tailed accounts  for  every  important  building 
and  machine  are  entered,  showing  the  orig- 
inal cost,  the  repairs  expended  thereon  since 
the  asset  was  acquired  and  also  during  the 
year,  and  the  estimated  annual  depreciation. 
The  total  sum  of  the  annual  depreciation 
against  each  item  forms  the  aggregate 
amount  of  the  depreciation  charge  for  the 
year  as  shown  on  the  general  books. 

Any  calculation  of  net  worth  must  take 
into  consideration  the  amount  of  deprecia- 
tion and  the  expenses  of  keeping  the  plant  in 
good  condition. 

Many  manufacturers  think  that  a  certain 
definitely  stated  percentage  of  depreciation 
used  by  one  manufacturer  may  be  safely 
used  by  all  manufacturers,  regardless  of  the 
character,  location,  and  condition  of  the  man- 
ufacturing plant,  and  also  regardless  of  the 
varied  personal  skill  exercised  in  the  opera- 
tion of  the  machinery. 

For  example,  a  pamphlet  prepared  by  a 


162    Net  Worth  and  the  Balance  Sheet 

"committee  of  accounts"  was  sent  to  all  the 
manufacturers  belonging  to  a  certain  associ- 
ation, and  in  this  pamphlet  it  was  stated  to 
be  well  settled  that  buildings  depreciate 
5  per  cent,  and  machinery  10  per  cent,  per 
annum.  There  is  no  such  settled  fact  or  prin- 
ciple. Buildings  and  machinery  of  exactly 
the  same  materials  and  make  will  not  de- 
preciate at  the  same  rate  in  Colorado  as  upon 
the  Atlantic  coast.  Nor  will  two  managers 
in  the  same  kind  of  business  direct  the  opera- 
tion of  the  machinery  of  their  different 
plants  in  the  same  way  and  with  the  same 
percentage  of  depreciation,  even  though  the 
volume  of  business  is  exactly  the  same. 

If  two  plants  exactly  alike  at  the  start  do 
not  depreciate  in  the  same  proportion,  how 
can  any  arbitrary  figure  be  applied  to  build- 
ings and  machinery  generally?  Each  plant 
must  be  carefully  studied  and  depreciation 
reserves  fixed  with  regard  to  the  circum- 
stances affecting  the  plant. 


S 


CHAPTER   XXVI 
RESERVES  (continued) 

OMETIMES  in  balance  sheets  the  re- 
serve for  bad  debts  or  for  depreciation 
is  stated  as  a  "Reserve  Fund,"  and  the  ques- 
tion is  raised  as  to  the  meaning  of  the  word 
"Fund"  used  in  that  connection.  In  the  ordi- 
nary use  of  the  term,  "Fund"  indicates  an 
asset  such  as  cash  or  its  equivalent.  Those 
who  regard  this  as  the  proper  and  only  mean- 
ing of  the  word  wonder  why  it  appears  on 
the  liability  side  of  a  balance  sheet.  Those 
who  use  the  term  to  designate  a  reserve  of 
profits  explain  that  a  reserve  is,  in  effect,  a 
setting  aside  of  profits  of  a  business  to  obtain 
funds  for  replacement  of  worn-out  build- 
ings and  machinery  and  that  the  reserve  ac- 
count shows  the  amount  of  such  fund.  In 
other  words,  it  is  an  account  of  the  profits 
reserved  to  provide  a  fund — a  Reserve  Fund 
account. 

With  some  concerns  it  is  the  practice  not 

163 


164     Net  Worth  and  the  Balance  Sheet 

only  to  set  the  profits  aside,  but  to  go  one 
step  further  and  invest  cash  in  securities  of 
other  corporations  to  the  amount  of  the  re- 
serve. Thus  the  invested  cash  becomes  the 
real  reserve  fund,  and  the  amount  which  may 
be  invested  is  shown  by  the  Reserve  Fund  ac- 
count. Since  the  word  "account"  on  a  bal- 
ance sheet  is  unnecessary,  as  all  of  the  items 
found  there  constitute  balances  of  accounts 
on  the  ledger,  or  of  accounts  which  would  be 
there  if  the  method  of  bookkeeping  were 
complete,  the  word  "account"  is  dropped, 
leaving  "Reserve  Fund,"  a  somewhat  cloudy 
term  when  used  as  a  liability.  But  the  term 
does  not  present  any  difficulty  to  one  familiar 
with  the  examination  of  balance  sheets, 
although  the  title  "Reserve  for  Deprecia- 
tion" or  "Reserve  for  Replacements"  is 
clearer. 

Another  important  account  appearing  on 
some  balance  sheets  as  a  liability  consists  of 
the  "Sinking  Fund,"  which  appears  when, 
under  the  terms  of  a  mortgage,  certain  defi- 
nite amounts  must  be  set  aside  periodically 
for  thepurpose  of  extinguishing  the  mortgage 


Reserves  165 

liability  when  it  matures.  In  some  of  these 
cases  the  fund  must  be  created  out  of  profits 
earned,  while  in  other  cases  it  is  immaterial 
how  it  is  created,  the  only  requirement  being 
that  instalments  be  actually  set  aside  and  in- 
vested each  year. 

If,  under  the  terms  of  the  mortgage,  or 
according  to  the  adopted  policy  of  the  com- 
pany, the  actual  money  must  be  set  aside  and 
invested,  the  asset  side  of  the  balance  sheet 
should  show  the  account  of  the  investment 
of  such  funds.  If  the  mortgage  contract 
does  not  provide  for  the  actual  investment 
of  the  fund,  it  may  be  left  in  the  business 
as  part  of  the  assets  of  the  business,  the  ac- 
count thereof  being  kept  as  a  liability,  or 
Sinking  Fund  Reserve,  increased  by  periodi- 
cal transfers  from  the  Profit  and  Loss  or 
Surplus  account. 

The  form  of  statement  shown  in  Chapter  I 
provides  for  a  grouping  of  the  "Reserves" 
in  one  amount,  which,  in  the  case  of  the  Scar- 
borough Manufacturing  Company,  consists 
of  the  following : 


166    Net  Worth  and  the  Balance  Sheet 

Sinking  Fund    $25,000 

Bad  and  Doubtful  Debts 3>OI7 

Depreciation  on  Buildings 32,000 

Depreciation  of  Machinery  and  Fixtures . .  48,400 

Total $108,417 

The  Sinking  Fund  Reserve  consists  of  five 
credits  of  $5,000  each.  The  Reserve  for  Bad 
and  Doubtful  Debts  amounts  to  about  3  per 
cent,  on  the  total  of  the  outstanding  accounts, 
which  in  this  case,  based  on  past  experience 
with  the  company's  customers,  is  a  sufficient 
provision. 

The  Depreciation  on  Buildings  consists  of 
an  accumulation  of  lump  sum  charges  ex- 
tending over  a  period  of  ten  years,  and  while 
not  based  upon  any  special  plan,  seems  to  be 
more  than  sufficient  for  depreciation.  The 
same  comment  may  be  made  on  the  Reserve 
for  Depreciation  of  Machinery  and  Fixtures. 
In  fact,  this  company  has  accumulated  re- 
serve credits  to  a  larger  amount  than  is  ordi- 
narily found  in  manufacturing  plants  of  its 
size. 


Reserves  16/ 

Hidden  Reserves 

Some  merchants  and  manufacturers  ir 
preparing  balance  sheets  are  so  conservative 
in  their  valuations  of  assets  that  the  balance 
sheets  do  not  represent  the  full  net  worth  of 
the  business.  While  it  is  commendable  for 
the  proprietor  of  a  business  to  understate 
rather  than  overstate  his  net  worth,  except, 
of  course,  under  conditions  wherein  the 
understatement  would  be  of  advantage  to 
him — as,  for  example,  in  preparing  tax  re- 
ports or  returns — it  is  a  much  better  prac- 
tice for  a  manufacturer  or  merchant  to  cal- 
culate his  net  worth  as  accurately  as  may 
be  without  either  over-  or  understating. 

Since  the  accumulated  profits  of  a  concern, 
set  aside  in  reserve  accounts  for  the  purpose 
of  guarding  against  embarrassment  from 
unexpected  shrinkages  of  the  assets,  consti- 
tute reserves  built  up  to  protect  those  assets, 
the  excess  of  the  actual  value  of  assets  over 
the  amount  shown  on  the  books  is  considered 
in  the  nature  of  another  reserve.  For  want 
of  a  better  name  the  term  "Hidden  Reserve" 
or  "Secret  Reserve"  is  used  to  indicate  that 


168    Net  Worth  and  the  Balance  Sheet 

a  concern  possesses  secret  or  hidden  reserves 
not  disclosed  on  its  balance  sheet,  these  secret 
or  hidden  reserves  consisting  of  resources 
not  claimed  in  the  process  of  striking  a  bal- 
ance and  producing  the  amount  of  net  worth. 
The  practice  is  one  of  doubtful  propriety. 
Of  course,  an  individual  sole  owner  of  a  busi- 
ness who  is  under  no  obligation  to  state  the 
full  value  of  his  business  may  follow  his  own 
inclinations  in  this  matter  without  question. 
An  example  of  the  extent  to  which  it  may 
be  carried  is  given  in  the  case  of  a  wealthy 
manufacturer,  among  whose  assets  is  listed 
a  large  wharf  or  pier,  on  which  are  erected 
numerous  buildings  for  shipping  purposes 
and  from  which  a  large  income  is  derived. 
While  this  pier  is  easily  worth  $750,000,  the 
owner  carries  its  value  on  his  balance  sheet 
at  $1  only,  its  real  value  having  been  reduced 
from  time  to  time  out  of  the  earnings  derived 
therefrom.  This  manufacturer's  actual  net 
worth,  as  compared  with  the  statement  of  his 
balance  sheet,  would  thus  contain  a  secret  or 
hidden  reserve  of  almost  the  entire  value  of 
this  pier,  taking,  of  course,  into  account 


Reserves  169 

reasonable  provision  for  ultimate  replace- 
ment. 

In  the  case  of  a  small  firm  the  condition 
might  be  such  that  the  inclination  of  the 
members  to  build  up  secret  reserves  could  be 
safely  followed,  but  even  in  such  cases  less 
difficulty  would  arise  upon  dissolution  of  the 
firm  by  death  or  otherwise  if  the  assets  were 
shown  within  a  reasonable  degree  of  value 
accuracy. 

But  when  we  come  to  the  accounting  of  a 
corporation,  particularly  one  whose  shares 
are  more  or  less  widely  held,  the  propriety 
of  materially  understating  the  assets  may  be 
questioned,  because  the  rights  of  sharehold- 
ers, past,  present,  and  future,  may  be  seri- 
ously affected  by  their  lack  of  knowledge  of 
the  actual  conditions. 

Methods  of  Building  Up  Secret  Reserves 

One  of  the  most  common  methods  of  cre- 
ating the  so-called  hidden  or  secret  reserve 
consists  in  an  excessive  charge  to  profit  and 
loss  for  depreciation  of  plant  assets;  the 
amounts  being  charged  direct  to  the  Profit 


Net  Worth  and  the  Balance  Sheet 

and  Loss  account,  and  the  credits  being  made 
direct  to  the  plant  asset  account,  the  effect 
being  to  reduce  the  book  value  of  the  plant 
asset  account  below  its  real  value. 

Another  method  of  hidden  reserve  build- 
ing consists  in  the  charging  of  enlargements 
of  a  plant  to  current  operating  expenses.  One 
large  concern  whose  published  statement  has 
been  issued  for  years  has  made  from  time  to 
time  extensive  additions  to  its  plant,  and 
without  any  effort  whatever  to  conceal  the 
practice,  charged  the  cost  of  these  additions 
to  operating  expenses.  The  result  is  that  the 
property  accounts  as  shown  on  the  books  are 
to-day  carried  at  a  value  far  below  their  real 
worth. 

In  this  case,  while  there  is  no  attempt  at 
deception,  the  practice  being  known  to  all 
concerned,  there  is  no  way  by  which  the  total 
amount  of  such  improvements  and  additions 
can  be  readily  obtained,  and  for  this  reason 
the  plan  is  not  to  be  recommended. 

In  another  case  an  entire  new  plant  was 
erected  without  any  increase  in  the  book 
value  of  the  plant  accounts  of  the  company, 


Reserves 

the  instalments  due  to  the  contractor  as  the 
building  progressed  being  paid  out  of  the 
current  earnings  of  the  company,  so  that  to- 
day this  large  building,  worth  over  a  million 
dollars,  does  not  appear  on  the  books  of  the 
company  at  all. 


CHAPTER   XXVII 
CONTINGENT  LIABILITIES 

/CONTINGENT  LIABILITIES  are  those 
^  amounts  not  directly  owed  by  the  mer- 
chant or  manufacturer,  but  zvhich  may  be- 
come direct  liabilities  upon  the  happening  of 
certain  contingencies. 

Since  the  balance  sheet  is  intended  to  in- 
clude only  direct  liabilities,  such  contingent 
liabilities  should  not  be  included  in  the  reg- 
ular statement  of  financial  condition,  but 
should  be  stated  as  footnotes. 

Notes  Discounted 

An  example  of  a  contingent  liability  is 
found  in  Notes  Receivable  which  have  been 
received  from  customers,  endorsed  by  the 
merchant  or  manufacturer  and  discounted  at 
bank.  Having  been  received  from  customers 
for  goods  sold,  the  makers  are  expected,  of 
course,  to  pay  them  at  maturity.  Should, 
however,  the  maker  of  any  such  note  fail 

172 


Contingent  Liabilities  173 

to  meet  his  obligation,  the  merchant  or  man- 
ufacturer receiving  and  discounting  the  note 
may  become  primarily  responsible  and  be 
obliged  to  pay.  If  he  keeps  a  proper  notes 
receivable  record,  he  will  at  all  times  be  able 
to  ascertain  the  amount  of  the  Notes  Receiv- 
able not  yet  due  on  which  he  may  become 
liable  in  the  event  that  the  maker  does  not 
pay.  The  Notes  Receivable  Book  referred 
to  is  a  useful  record,  showing  details  of  notes 
received,  such  as  date,  amount,  maker,  in- 
dorsee, maturity,  etc.  It  is  sometimes  in- 
corporated in  the  bookkeeping  system,  but  is 
more  frequently  used  only  as  a  memorandum 
book. 

It  will  be  remembered  that  under  the  dis- 
cussion of  Notes  Receivable  it  was  said  that 
some  concerns  show  the  contingent  liability 
for  Notes  Discounted  in  the  body  of  the  bal- 
ance sheet.  This  is  done  by  crediting  on  their 
books  in  a  Bills  Receivable  Discounted  ac- 
count all  of  the  notes  discounted,  against 
which  they  charge  all  notes  as  they  are  paid 
by  the  makers,  so  that  the  balance  of  this  ac- 
count shows  the  amount  of  unpaid  notes 


174    Net  Worth  and  the  Balance  Sheet 

which  have  been  discounted  but  which  have 
not  yet  been  paid. 

Where  such  a  system  is  in  use,  of  course, 
no  footnote  showing  the  contingent  liability 
for  notes  discounted  is  required. 

Accommodation  Paper 

Another  form  of  contingent  liability  con- 
sists of  that  arising  from  accommodation 
indorsements. 

Any  accommodation  paper  made  by  the 
merchant  or  manufacturer  or  indorsed  by 
him  for  the  benefit  of  other  parties,  the  pro- 
ceeds of  which  are  not  received  by  him  and 
entered  on  his  books,  should  be  stated  as  a 
Contingent  Liability. 

Any  liability  for  exchanged  notes,  drafts, 
or  checks,  and  any  liability  for  guaranty  or 
suretyship  should  also  be  stated. 

Ordinary  business  concerns  are  usually 
very  chary  about  lending  the  use  of  their 
names  on  promissory  notes  for  the  accommo- 
dation of  the  makers.  In  fact,  in  some  cor- 
porations this  favor  is  prohibited  under  the 
charter  and  by-laws,  and  in  some  partner- 


Contingent  Liabilities  175 

ship  agreements  no  one  member  of  the  firm  is 
allowed  to  indorse  promissory  notes,  either 
in  his  own  name  or  the  name  of  the  firm,  for 
any  outside  parties  or  for  any  outside  pur- 
pose. So  many  business  failures  have  been 
brought  about  through  friendly  but  unwise 
indorsement  of  promissory  notes  that  such 
provisions  must  be  regarded  as  measures  of 
mere  ordinary  business  procedure. 

Unfortunately,  concerns  whose  credit  and 
capital  are  limited  do  sometimes  exchange 
such  accommodations  with  each  other.  In 
one  case,  a  small  manufacturing  corporation, 
through  the  aid  of  certain  loose-principled 
note  brokers,  managed  to  exchange  notes 
with  thirteen  other  manufacturing  concerns 
in  similarly  crippled  financial  condition.  Of 
course  the  inevitable  collapse  took  place  after 
a  short  period  of  easy  financing,  and  the  one 
concern  having  least  need  for  such  irregular 
methods  had  to  bear  the  brunt  of  the  total 
failure  of  all  of  the  other  concerns  on  whose 
paper  it  had  indorsed  its  name.  Besides  its 
own  direct  liability  on  promissory  notes  given 
to  the  others  for  their  accommodation,  this 


176 

concern  had,  in  addition,  its  contingent  lia- 
bilities for  its  indorsements  on  the  notes  of 
all  of  the  others — a  condition  which  even- 
tually brought  it  into  the  bankruptcy  court. 

Liabilities  Not  Shown  by  Books 

In  examining  his  own  balance  sheet  or 
that  of  others  the  business  man  or  investor 
should  satisfy  himself  by  inquiry  that  there 
are  no  liabilities,  contingent  or  direct,  other 
than  are  shown  on  the  statement. 

Merchants  or  manufacturers  may  and  fre- 
quently do  enter  into  contracts  for  purchase 
or  sale  of  goods,  and  sometimes  participate 
in  syndicates  or  subscribe  for  corporation 
securities,  thereby  incurring  liabilities  which 
by  their  nature  may  not  be  entered  on  the 
books  in  any  ordinary  bookkeeping.  These 
may,  however,  have  a  material  effect  on  the 
financial  condition  of  the  individual  or  con- 
cern at  the  time  the  balance  sheet  is  made, 
according  to  the  favorable  or  unfavorable 
happening  or  turn  of  events.  At  the  time 
the  balance  sheet  is  prepared,  any  knowledge 
of  events  which  may  forecast  loss  or  disaster 


Contingent  Liabilities  177 

should  be  faced  squarely  by  the  merchant  or 
manufacturer  if  he  wishes  to  avoid  self- 
deception,  even  though  such  knowledge 
comes  to  him  before  the  time  for  the  per- 
formance of  the  disastrous  contract  or  en- 
gagement. 


CHAPTER   XXVIII 
ANALYSIS  OF  BALANCE  SHEET 

1-J  AVING  considered  the  nature  of  the  ac- 
counts forming  the  balance  sheet  shown 
in  Chapter  II,  let  us  see  whether  we  can  de- 
rive any  information  from  the  grouped 
accounts  of  this  same  balance  sheet,  express- 
ing as  they  do  the  net  worth  of  the  business. 
The  balance  sheet  of  the  Scarborough  Man- 
ufacturing Company  presents  a  typical  case 
of  a  corporation  statement  reshaped  to  con- 
form to  the  requirements  of  the  American 
Bankers'  Association. 

One  of  the  first  things  to  consider  in  the 
analysis  of  a  balance  sheet  is  the  "liquid" 
condition  of  the  assets  as  compared  with  its 
immediate  liabilities.  The  statement  of  the 
Scarborough  Manufacturing  Company  pre- 
sents a  very  favorable  condition  from  a 
banker's  point  of  view.  Cash,  Bills  Receiv- 
able, Accounts  Receivable,  and  Merchandise, 
representing  what  are  usually  called  "quick" 

178 


Analysis  of  Balance  Sheet         179 

or  "liquid"  assets,  amount  to  about  $370,000, 
while  the  "quick"  liabilities — Notes  Payable, 
Accounts  Payable,  and  Deposits — amount  to 
but  $88,000  in  round  numbers.  This  con- 
dition presents  a  desirable  one,  in  that  the 
"quick"  assets  exceed  the  "quick"  liabilities 
in  the  ratio  of  about  4J4  of  assets  to  1  of 
liabilities. 

Of  course  the  nature  of  the  business  is 
taken  into  consideration,  but  banks  as  a  rule 
do  not  look  with  favor  upon  a  statement 
unless  it  shows  at  least  $2  of  "quick"  assets 
for  every  $1  of  "quick"  liabilities. 

Readings  from  the  Balance  Sheet 

That  the  Scarborough  Manufacturing 
Company  is  somewhat  easy-going  is  evi- 
denced by  the  large  cash  balance  as  compared 
with  the  amount  of  accounts  payable  out- 
standing. It  is  probable  that  active  efforts 
directed  toward  reducing  that  liability  might 
result  in  material  savings  in  the  way  of  cash 
discounts. 

Again,  the  credit  terms  of  this  concern  to 
its  customers  average  45  days,  but  through 


180     Net  Worth  and  the  Balance  Sheet 

easy  collection  methods  it  has  allowed  about 
$25,000  of  overdue  outstanding  accounts  to 
remain  uncollected. 

Another  evidence  of  slack  methods  is 
shown  in  the  large  amount  of  merchandise 
on  hand,  which  equals  about  one-third  of  the 
total  volume  of  sales  for  the  year,  while,  as 
we  have  seen,  the  natural  "turn-over,"  ac- 
cording to  the  accounts  receivable,  occurs 
about  nine  times  each  year.  In  other  words, 
with  a  volume  of  sales  of  $680,000,  and  with 
a  credit  period  averaging  45  days,  the  amount 
of  stock  on  hand  in  excess  of  $80,000  could 
only  be  justified  by  a  process  of  manufacture 
requiring  an  unusually  long  period  as  com- 
pared with  the  credit  terms  upon  which  this 
stock  is  sold — a  condition  which  does  not 
exist  in  the  case  under  consideration. 

Another  evidence  of  an  easy-going  man- 
agement, not  pressed  by  necessity  or  keen 
watchfulness,  is  shown  in  the  mortgage  of 
$5,000  on  certain  property  owned  by  the 
company,  on  which  it  is  paying  6  per  cent, 
interest.  Its  bank  balance  is  producing  no 
interest  whatever.  Keen  financial  men  abhor 


Analysis  of  Balance  Sheet         181 

conditions  under  which  they  unnecessarily 
pay  more  interest  than  is  earned. 

It  is  very  evident  from  the  statement  that 
the  company  has  enjoyed  rather  more  than 
average  prosperity  since  it  has  been  able  to 
accumulate  a  large  surplus,  besides  setting 
aside  ample  reserve  provisions,  in  spite  of  its 
easy-going  propensities. 

Those  in  charge  probably  know  very  much 
about  what  is  called  the  practical  end  of  the 
business,  and  in  that  are  evidently  sufficiently 
successful  to  be  able  to  ignore  phases  of  the 
business  which  in  other  concerns  receive  the 
utmost  care.  Of  course,  the  net  result  would 
be  better  if  the  loose  ends  could  be  gathered 
in  without  sacrifice  elsewhere. 


CHAPTER   XXIX 

COMPARISON  OF  SUCCESSIVE  BALANCE 
SHEETS 

TF  a  single  balance  sheet  will  convey  solid 
•*•  information  regarding  the  concern  whose 
condition  it  represents,  how  much  more  is 
gained  by  a  comparison  of  the  balance  sheets 
of  the  same  concern  for  two  or  more  con- 
secutive years? 

Let  us  take  the  balance  sheets  of  a  large 
public  service  corporation  for  the  years  1910 
and  1911  and  set  the  figures  side  by  side  for 
comparison. 

THE   INTERNATIONAL    SERVICE 

COMPANY 

Assets                       1910  1911 

Cost  of  Property $557,417,146  $610,999,964 

Contracts  in  Process ..       7,212,781  2,943,381 

Inventories 17,048,196  20,987,551 

Accounts  Receivable. .     49,744,919  26,077,802 

Cash 32,055,866  27,548,933 

Investments   38,166,284  64,766,089 

Total... $701,645,192    $753.323.720 

182 


Comparison  of  Balance  Sheets     183 

Liabilities                   I9IO  I9II 

Capital  Stock $352,904,063  $344,645,430 

Surplus  and  Reserves.     95,700,385  119,598,526 

Bonded  Debt 187,685,339  224,791,696 

Bills   Payable 40,721,625  42,566,943 

Accounts  Payable 24,633,780  21,721,125 

Total $701,645,192  $753,323-720 


Cost  of  Property  Account 

It  will  be  observed  that  in  the  foregoing 
form  of  balance  sheet  the  accounts  are  ar- 
ranged somewhat  differently  from  those  of 
the  two  other  balance  sheets  which  have 
already  been  shown. 

The  property  account  of  one  of  the  prior 
examples  appears  here  in  a  more  definitely 
named  "Cost  of  Property"  account.  While 
an  analysis  of  the  account  might  perhaps 
show  the  assets  to  be  worth  less  than  the 
amount  at  which  they  are  carried  on  the 
books,  the  balance  sheet  is  evidently  intended 
to  convey  the  impression  that  whatever  the 
value  of  the  property,  its  cost  is  here  stated. 

Xow  we  naturally  turn  to  the  record  of 
depreciation  to  learn  the  amount  charged  off 


184    Net  Worth  and  the  Balance  Sheet 

as  a  provision  against  the  shrinkage  of  prop- 
erty values,  but  here  we  are  met  with  an 
obscurity.  The  surplus  and  the  reserve  ac- 
counts, instead  of  being  stated  separately, 
are  thrown  together  in  one  lumped  account, 
so  that  we  cannot  tell  just  how  much  the  com- 
pany has  thought  necessary  to  set  aside  as 
a  reserve  against  the  depreciation  of  its 
costly  plant. 

We  may  observe,  however,  that  the  cost 
of  the  property  exceeds  the  entire  amount 
of  capital  stock  issued.  In  fact,  it  exceeds 
that  amount  in  addition  to  the  entire  bonded 
debt.  This  is  as  far  as  we  can  go  in  this 
direction  without  asking  the  management 
questions. 

Results  of  Operation 

Now  let  us  see  the  result  of  the  operations 
of  this  company  as  disclosed  in  these  two 
statements.  We  notice  that  no  two  of  the 
amounts,  either  of  the  assets  or  liabilities,  re- 
main the  same  for  both  years.  What  funds 
did  this  company  handle  during  the  year  and 
what  did  it  do  with  them  ? 


Comparison  of  Balance  Sheets     185 

Take  the  assets  first.  Which  of  them  were 
decreased  ?  We  ask  this  question  because  we 
know  that  if  an  asset  was  decreased  during 
the  year,  it  is  probable  in  the  natural  course 
of  events  that  the  amount  of  the  decrease 
represents  cash  realized.  Assets  may  be,  of 
course,  writen  down  or  taken  off  from  the 
books  altogether  without  producing  anything 
but  loss,  but  where  reserve  accounts  are  kept 
and  property  is  carried  at  cost,  it  is  not  prob- 
able that  the  asset  values  were  reduced  ex- 
cepting for  cash  realized. 

The  Accounts  Receivable, 

On  December  31,  1910,  amounted  to.  .$49,744,919 
While    on    December    31,    1911,    the 

amount  was    26,077,802 


A  decrease  of $23,667,117 

which  means  that  an  amount  equal  to  the 
entire  current  accounts  for  the  year  was  col- 
lected, and  additional  collections  were  made 
to  the  extent  of  $23,667,117,  thus  increasing 
the  company's  working  capital  by  this 
amount. 


186    Net  Worth  and  the  Balance  Sheet 

On  the  other  hand — 

Cost  of  Property  in  1911  was $610,999,964 

While  in  1910  the  amount  was 557,417,146 


An  increase  of $53,582,818 

which  shows  that  an  increase  of  property 
took  place  during  the  year,  consuming  funds 
to  the  extent  of  $53,582,818.  That  this  did 
not  all  come  from  capital,  either  in  the  form 
of  share  capital  or  increase  in  bonded  in- 
debtedness, is  clear  when  we  observe  that  the 
outstanding  capital  stock  actually  decreased. 
While  the  bonded  debt  increased  $37, 106,357, 
the  amount  is  still  about  $16,000,000  less 
than  the  additions  to  plant. 

Comparison  of  Asset  and  Liability  Variations 

Where  did  the  company  obtain  the  funds 
to  purchase  this  additional  property?  We 
know  that  the  increase  of  liabilities,  repre- 
sented by  accounts  or  notes  payable,  or  by 
bonded  debt  or  share  capital,  should  produce 
a  corresponding  increase  of  assets  in  some 
form,  and  that  the  reduction  of  such  liabili- 
ties calls  for  the  parting  with  assets. 


Comparison  of  Balance  Sheets     187 

Combining  the  decrease  of  assets  and  the 
increase  of  liabilities,  we  get  the  following 
results : 

DECREASES  OF  ASSETS  AND  INCREASES 
OF  LIABILITIES: 

Contracts (decrease)  $4,269,400 

Accounts   Receivable (decrease)  23,667,117 

Cash (decrease)     4,506,933 

Bonded  Debt (increase)  37,106,357 

Bills  Payable (increase)     1,845,318 

Surplus  and  Reserves (increase)  23,898,141 

Total $95,293,266 


This  represents  the  total  amount  which 
during  the  year  became  available  for  expen- 
diture on  any  one  of  the  items  in  the  balance 
sheet.  Of  course  this  calculation  does  not 
furnish  us  with  the  gross  earnings  or  the 
operating  expenses.  We  do  not  have  the 
profit  and  loss  statement  before  us.  That 
has  all  been  boiled  down  to  the  remaining 
"Surplus  and  Reserves,"  the  increase  of 
which  is  all  we  have  to  serve  as  a  guide.  Fur- 
ther along  the  line  of  detailed  operation  we 
cannot  go,  but  we  do  know  that  after  cur- 


188     Net  Worth  and  the  Balance  Sheet 

rent  operating  revenues  and  expenditures 
have  been  accounted  for,  there  is  a  decrease 
of  assets  and  an  increase  of  liabilities  aggre- 
gating $95,000,000,  which  was  spent  some- 
where. Where  did  the  money  go  ? 

Our  answer  will  be  found  if  we  take  all  of 
the  items  of 

INCREASES  OF  ASSETS  AND  DECREASES 
OF   LIABILITIES: 

Cost  of  Property (increase)  $53,582,818 

Inventories    (increase)       3.939,355 

Investments (increase)     26,599,805 

Capital  Stock   (decrease)       8,258,633 

Accounts  Payable (decrease)       2,912,655 

Total $95,293,266 


We  have  thus  fully  accounted  for  the  ex- 
penditure of  the  funds.  That  part  of  the 
funds  expended  which  was  not  derived  from 
an  increase  in  the  bonded  debt,  less  retire- 
ment of  share  capital  with  the  small  increase 
in  Bills  Payable,  came  from  the  earnings  of 
the  company  and  collections  of  accounts. 
A  Study  of  Earnings 

We  have  one  more  fact,  obtained  from  the 


Comparison  of  Balance  Sheets      189 

public  records,  showing  that  this  company 
paid  7  per  cent,  dividends  during  1911  on  its 
entire  capital  stock;  an  aggregate  of  over 
$24,000,000  being  so  disbursed.  Taking  this 
fact  into  consideration  with  the  balance 
sheet,  where  we  see  an  increase  in  the  surplus 
and  reserve  accounts  of  nearly  $24,000,000, 
it  will  be  seen  that  this  company  earned  about 
14  per  cent,  on  its  capital  stock. 

When  we  know  something  about  the  earn- 
ings of  a  corporation  we  can  go  still  further 
in  a  dissection  of  its  balance  sheet.  In  one 
case  it  was  claimed  by  parties  interested  that 
a  certain  corporation  was  charging  off  for 
depreciation  entirely  too  large  an  amount. 
Upon  analysis  it  was  found  that  the  depre- 
ciation charge  for  the  year  was  $270,000. 
The  amount  of  this  depreciation  charge  was 
stated  as  a  Reserve  for  Replacement,  the 
annual  amount  being  charged  to  the  Profit 
and  Loss  account  and  credited  to  the  account 
as  described.  Condensed  statements  of  as- 
sets and  liabilities  and  earnings  only  were 
submitted.  The  increase  in  the  amount  of 
the  plant  during  the  last  year  aggregated 


190     Net  Worth  and  the  Balance  Sheet 

$407,375.12,  while  the  capital  account  was 
not  increased  at  all. 

An  analysis  was  made  as  follows: 

Net  earnings  from  operations $485,330.33 

Add  increase  in  current  liabilities. . . .     27,648.65 


$512,978.98 
Deduct  increase  in  current  assets. . . .     42,392.64 


$470,586.34 

Reserve  account  at  the  beginning  of 

the  year $60,133.63 

Add  appropriation  for  the  year 270,000.00 


Amount    available    for    replacements 

during  the  year 
Amount  of  Reserve  account  at  end  of 

year    266,922.41 


Amount  expended  in  replacements...  $63,211.22 


Now  if  we  bring  down  the  amount  of 
available  funds  as  shown  in  the  foregoing 
statement,  $470,586.34,  and  deduct  the 
amount  expended  for  replacements  of  worn- 
out  equipment,  $63,211.22,  we  have  a  re- 


Comparison  of  Balance  Sheets      191 

mainder  of  $407,375.12,  which  represents 
the  amount  taken  out  of  earnings  to  provide 
new  capital  items,  agreeing  with  the  differ- 
ence between  the  plant  account  at  beginning 
and  ending  of  the  year. 

Two  things  are  observed  here.  First,  the 
management,  instead  of  paying  dividends, 
used  the  earnings  to  buy  additional  plant; 
and,  second,  the  depreciation  charge  to  Profit 
and  Loss  for  the  purpose  of  providing  a  re- 
serve for  the  replacement  of  worn-out  equip- 
ment was  larger  than  was  actually  neces- 
sary. 

The  cash  earnings  of  the  company  were 
thus  consumed  and  no  dividends  declared — 
a  matter  in  which  the  stockholders  would  nat- 
urally be  interested. 

Tracing  Increases  of  Assets 

Another  interesting  phase  of  increased 
assets  is  shown  in  the  following  comparison 
of  two  balance  sheets  of  the  Rodman  Pro- 
duction Company,  taken  at  the  close  of  two 
successive  years: 


192     Net  Worth  and  the  Balance  Sheet 


Assets 

1908  1909 

Cash  ..................  $27,37077  $17,909-97 

Accounts  Receivable.  ...165,659.31  146,293.18 

Stock    .................  97,049-75  496,439-8o 

Real  Estate  ............  223,329.30  251,572.52 

Good-Will   ............  150,000.00  150,000.00 

Deficit  .................   50,123.99 

$7I3,533-I2  $1,062,215.47 

Liabilities 

Notes  Payable  ........  $133,565-96  $165,989.59 

Accounts   Payable  .....     79,967.16  230,026.21 

Surplus  ..............  166,199.67 

Capital  Stock  .........  500,000.00  500,000.00 


$1,062,215.47 


It  will  be  noticed  that  on  the  face  of  the 
statements  this  company  did  remarkably  well 
during  the  last  year,  changing  a  deficit  or 
impairment  of  its  capital  in  the  amount  of 
$50,123.99  to  a  surplus  of  $166,199.67.  If 
we  had  access  to  the  books  we  would  probably 
find  that  these  two  amounts  added  together 
represent  the  credit  to  the  Profit  and  Loss 
account  as  its  earnings  for  the  year. 


Comparison  of  Balance  Sheets      193 

But  note  carefully  the  increase  and  de- 
crease of  assets  and  see  whether  anything 
exists  there  to  warn  us  against  a  too  quick 
conclusion  that  the  company  has  actually 
made  all  of  the  money  that  the  improved  con- 
dition of  its  Surplus  account  would  seem  to 
indicate. 

The  cash  and  accounts  receivable  among 
the  assets  decreased  about  $28,000,  and  the 
notes  and  accounts  payable  increased  about 
$180,000.  But  notice  the  increase  in  the 
stock  of  manufactured  goods,  the  amount  in 
excess  of  that  of  the  previous  year  being 
nearly  $400,000. 

The  first  thought  which  comes  to  mind  is 
that  the  stock  has  been  piling  up.  Then  one 
is  inevitably  moved  to  ask  at  what  price  the 
goods  were  valued  in  the  inventory.  If  taken 
at  actual  cost,  the  profit  on  the  goods  actually 
sold  during  the  year  is  remarkable.  But  if  the 
inventory  was  taken  at  selling  price,  the  large 
increase  of  stock  is  seen  to  be  less  than  it 
appears  to  be,  and  the  large  profit  apparently 
made  in  the  one  year  is  partly  explained  as 
a  book  profit,  not  of  course  actually  earned. 


194     Net  Worth  and  the  Balance  Sheet 

It  is  obvious  that  if  finished  goods  are  in- 
ventoried by  the  manufacturer  at  any  value 
above  cost,  it  will  be  possible  for  him  to  man- 
ufacture a  large  stock  of  goods,  and  show  a 
profit,  without  selling  a  dollar's  worth. 

This  concern  borrowed  about  $180,000 
additional  capital,  and  probably  put  it  all  into 
the  increased  stock,  which  if  carried  at  cost 
might  show  an  increase  of  approximately 
the  amount  borrowed;  this  in  addition,  of 
course,  to  the  increase  made  possible  by  the 
expenditure  of  funds  arising  out  of  the 
profits  on  the  business  which  was  actually 
transacted. 

Since  the  stock  increased  to  an  amount 
over  twice  the  amount  of  additional  capital 
obtained,  it  may  be  quite  necessary  for  an 
examination  of  the  inventory  values  to  be 
made,  in  order  to  determine  whether  the  ap- 
parent profit  was  real  and  to  eliminate  any 
profit  taken  in  advance  of  the  actual  sale  of 
the  goods. 

In  the  case  of  a  large  tool  manufacturing 
company,  this  method  of  inventorying  was 
carried  so  far  that  in  one  year,  when  its  sales 


Comparison  of  Balance  Sheets      195 

had  decreased  to  about  one-half  of  normal, 
it  was  not  only  able  to  pay  the  usual  dividend, 
but  to  show  in  addition  an  increase  in  its 
Surplus  account. 

If  this  process  could  go  on  indefinitely  the 
bed  of  a  business  man  might  easily  be  con- 
structed of  roses ;  but  the  practice  of  realiz- 
ing on  anticipated  profits  leads  sooner  or 
later  to  serious  trouble. 

There  is  no  safe  course  for  a  merchant  or 
manufacturer  to  pursue  other  than  that  based 
upon  a  complete  understanding  of  his  affairs. 
Such  a  statement,  if  prepared  according  to 
the  outline  which  we  have  discussed  in  this 
little  book,  ought  to  furnish  him  with  at  least 
the  foundation  of  that  understanding. 


INDEX 


Accommodation  Notes,  39-41,  174-176. 
Account,  Cost  of  Property,  183,  184. 
Accounts,  Changes  in,  17,  18. 
Accounts  Payable,  120-123. 

Not  Due,  121,  122. 

Overdue,  121,  122. 
Accounts  Receivable,  17,  18,  48-61. 

Advances,  61. 

as  Collateral,  49-51. 

Bad  and  Doubtful,  56,  57,  74. 

Collecting,  58-60. 

from  Allied  Interests,  60,  61. 

"Good,"  52,  53. 

in  which  Surplus  May  Appear,  150,  151. 

Overdue,  53-55. 

Restricted  Meaning  of,  49,  51,  52. 

Unsettled  Charges,  57,  58. 
Accrued  Liabilities,  135-137. 
Advances  of  Cash,  61. 
Analysis  of  Balance  Sheet,  178-181. 

of  Earnings,  190,  191. 
Arrangement  of  Balance  Sheet,  19-22. 
Assigned  or  Pledged  Notes  Receivable,  45-47. 

Entry  of,  47. 
Assets, 

Deferred,   112. 

Increases  of,  Tracing,  191-195. 

Other,  28-29,  98-115.  (See  also  Other  Assets.) 
197 


198  Index 

Assets — (Continued) 
Valuation  of,  15,  16. 
Variations  in,  186-188,  191-195. 

B 
Bad  and  Doubtful  Accounts,  56,  57,  74. 

Reserve  for,  158-160. 
Balance,  Cash,  23,  24. 
Balance  Sheets,  17-22,  178-195. 
Analysis  of,  178-181. 
Arrangement  of,  19-22. 
Comparison  of  Successive,  182-195. 
A  Study  in  Earnings,  188-191. 
Cost  of  Property  Account,  183,  184. 
Results  of  Operation,  184-186. 
Tracing  Increases  of  Assets,  191-195. 
Form  of,  18-22,  144. 

English,  19,  20. 
Readings  from,  179-195. 
Bank,  Cash  in,  24-28. 
Bills  Payable,  116,  117. 
Bills  Receivable,  31. 
Bonded  Debt,  127-129. 
Bonds,  Kinds  of,  128,  129. 
Books,  Notes  Receivable,  173. 
Building  Up  Secret  Reserves,  169-171. 
Buildings,  89,  90. 

Depreciation  of,  162,  166. 
Business  Investments,  100,  101. 

C 

Capital  or  Net  Worth,  138-140. 
Capital  Stock,  140-146. 

Common,  140,  141,  143. 

Entry  of,  140. 

Issued  for  Property,  143-146. 


Index  199 

Capital  Stock — (Continued) 

Preferred,  140-143,  145. 
Cash,  23-30. 

Balance,  23,  24. 

in  Bank,  24-28. 
Deposits,  25-27. 

on  Hand,  28,  29. 

Petty,  29,  30. 

Changes  in  Accounts,  17,  18. 
Classification  of  Surplus,  151. 
Collateral,  Accounts  Receivable  as,  49-51. 

Merchandise  as,  70,  71. 

Notes  Payable  as,  118,  119. 

Notes  Receivable  as,  45-47. 
Collecting  Accounts  Receivable,  58-60. 
Collections,  27,  28. 
Common  Stock,  140,  141,  143. 
Comparison  of  Asset  and  Liability  Variations,  186-188,  191- 

195. 
Comparison  of  Successive  Balance  Sheets,  182-195. 

A  Study  in  Earnings,  188-191. 

Cost  of  Property  Account,  183,  184. 

Results  of  Operation,  184-186. 

Tracing  Increases  of  Assets,  191-195. 
Consignments,  76,  77. 
Contingent  Liabilities,  172-177. 

Accommodation  Paper,  174-176. 

Not  Shown  by  Books,  176,  177. 

Notes  Discounted,  172-174. 
Corporate  Deficit,  155,  156. 
Corporate  Surplus,  152-156. 

Liability  for,  154,  155. 
Cost,  Manufacturing,  69,  73-76. 

of  New  Business,  107,  108. 

Records  and  Prices,  68-70. 
Cost  of  Property  Account,  183,  184. 


200  Index 

D 

Debentures,  129. 

Debt,  Bonded,  127-129. 

Debts,  Bad  and  Doubtful,  56,  57,  74. 

Reserve  for,  158-160. 

Decreases  of  Assets  and  Liabilities,  186-188. 
Deferred  Assets,  112. 
Deficit,  Corporate,  155,  156. 
Deposits,  25-27,  124-126. 
Depreciation  of  Machinery  and  Fixtures,  166. 

of  Plant,  160-164. 

Reserve  for,  160-164,  166. 
Discounting  Notes  Receivable,  32-37,  172-174. 

Entry  of,  33-36. 


Earnings,  A  Study  in,  188-191. 

Surplus  Not  from,  148-150. 
Employes'  Savings  Fund,  124,  125. 
Entry  of  Capital  Stock,  140. 

of  Mortgages,  131-133. 

of  Notes  Receivable,  33-36. 

F 

Finished  Product,  72-77. 

Consignments,  76,  77. 

Manufacturing  Cost  of,  73-76. 

Valuation  of,  73-76. 
Fixtures,  Furniture  and,  96,  97. 

Machinery  and,  91-95. 

Depreciation  of,  166. 
Form  of  Balance  Sheet,  18-22,  144. 

English  Form,  19,  20. 
Fund,  Employes'  Savings,  124,  125. 

Imprest,  29,  30. 


Index  201 


Fund —  (  Continued  ) 

Reserve,  163-166. 

Sinking,  164-166. 
Furniture  and  Fixtures,  96,  97. 


"Good"  Accounts  Receivable,  52,  S3. 
"Good"  Notes  Receivable,  37,  38. 
Goods.     (See  Merchandise.) 
Good-Will,  Valuation  of,  108-111. 

H 

Hidden  Resents,  167-171. 

I 

Imprest  Fund,  29,  30. 
Increases  of  Assets,  Tracing,  191-195. 

of  Assets  and  Liabilities,  186-188,  191-195. 
Inventory,  Machinery,  94,  95. 

Perpetual,  79-82. 
Investments,  Business,  100,  101. 

Reserve  Fund,  112-114. 


Land  and  Buildings,  89,  90. 

Leaseholds,  89. 

Liability  of  Corporation  for  Surplus,  154,  155. 

of  Mortgagor,  131,  132. 
Liabilities, 

Accrued,  135-137. 

Contingent,  172-177.     (See  also  Contingent  Liabilities.) 

for  Taxes,  137. 

Other,  134-137. 

Pay  Roll,  136. 

Variations  in,  186-188,  191-195. 


202  Index 

M 

Machinery — Fixtures,  91-95. 

Depreciation  of,  166. 

Inventory,  94,  95. 

Partly  Paid,  95. 

Valuation  of,  92-95. 
Manufacturing  Cost,  69,  73-76. 
Materials, 

Finished,  72-77. 

Partly  Finished,  78-82. 

Raw,  83-85. 
Merchandise,  62-71. 

as  Collateral.  70,  71. 

on  Hand,  70,  71. 

Valuation  of,  62-70. 
Missionary  Work,  107,  108. 
Mortgages,  127-129,  130-133. 

Entry  of,  131-133. 

Securing  Bonds,  127-129. 
Mortgagor,  Liability  of,  131,  132. 

N 

Net  Worth,  13-16,  138-140,  153,  167,  168. 

Definition  of,  13. 

Indicates  Business  Progress,  16. 

Theory  of,  13-15. 

What  Constitutes,  14,  15. 
"New  Business"  Cost,  107,  108. 
Non-Negotiable  Notes,  39. 
Notes,  Accommodation,  39-41,  174-176. 
Notes  Payable,  116-119. 

for  Money  Borrowed,  118,  119. 
Notes  Receivable,  31-47. 

Accommodation,  39-41,  174-176. 


Index  203 


Notes  Receivable — (Continued) 
as  Collateral,  45-47. 
Assigned  or  Pledged,  45-47. 

Entry  of,  47. 
Book,  173. 
Discounting,  32-37,  172-174. 

Entry  of,  33-36. 
"Good,"  37-38. 
Non-Negotiable,  39. 
Not  in  Ordinary  Course,  41-45. 
Pledged  as  Collateral,  47. 


Operation,  Results  of:  184-186. 
Other  Assets,  28,  29,  98-115. 

Business  Investments,   100,   101. 

Cost  of  "New  Business,"  107,   108. 

Deferred  Assets,  112. 

Other  Investments,  114,  115. 

Reserve  Fund  Investments,   112-114. 

Treasury  Stock,  99,  100. 

Valuation  of  Good-Will,  108-111. 

Valuation  of  Patterns,  101-105. 

Valuation  of  Trade-Marks,  105,  106. 
Other  Liabilities,  134-137. 
Overdue  Accounts  Payable,  121,  122. 
Overdue  Accounts  Receivable,  53-55. 

Analysis  of,  54,  55. 


Paper,  Accommodation,  39-41,  174-176. 
Partly  Finished  Product,  78-82. 

Cost  of,  78-82. 

Perpetual  Inventory,  79-82. 


204  Index 

Partly  Finished  Product— (Continued) 

Patterns,  Valuation  of,  101-105. 

Pay  Roll  Liability,  136. 

Perpetual  Inventory,  79-82. 

Petty  Cash  and  Imprest  Fund,  29,  30. 

Plant,  Depreciation  of,  160-164,  166. 

Pledged  Notes  Receivable,  45-47. 

Entry  of,  47. 

Preferred  Stock,  140-143,  145. 
Prices,  Fixing,  68-70. 
Product, 

Finished,  72-77. 

Partly  Finished,  78-82. 
Fronts,  147-156.     (See  also  Surplus.) 

Taking,  63,  64,  68,  69. 
Property  Account,  183,  184. 

Stock  Issued  for,  143-146. 


R 

Raw  Material,  83-85. 

Valuation  of,  83,  84. 
Real  Estate,  87-90. 

Leaseholds,  89. 

Mortgages  on,  127-133. 

Valuation  of,  87,  88. 
Reserve  Fund  Investments,  112-114. 
Reserves,  157-171. 

for  Bad  and  Doubtful  Debts,  158-16U 

for  Depreciation  of  Machinery  and  Fixtures,  166. 

for  Depreciation  of  Plant,  160-164,  166. 

Fund,  163-166. 

Hidden   or   Secret,   167-171. 
Building  Up,  169-171. 


Index  206 


Reserves —  (  Continued  ) 

Sinking  Fund,  164-166. 
Rights  of  Stockholders,  155. 


Secret  Reserves,  167-171. 

Building  Up,  169-171. 
Sinking  Fund,  164-166. 
Stock, 

Capital,  140-146. 

Common,  140,  141,  143. 

Issued  for  Property,  143-146. 

Preferred,  140-143,   145. 

Treasury,  99,  100. 
Stockholders,  Rights  of,  155. 
Supplies  on  Hand,  85,  86. 
Surplus,  147-156. 

Accounts  in  Which  It  May  Appear,  150,  151. 

Classification  of,  151. 

Corporate,  152-156. 
Liability  for,  154,  155. 

Meaning  of,  147. 

Not  from  Earnings,  148-150. 

Where  Entered,  150,  151. 


Taxes,  Liability  for,  137. 
Theory  of  Net  Worth,  13-15. 
Trade-Marks,  Valuation  of,  105,  106. 
Treasury  Stock,  99,  100. 


Valuation  of  Assets,  15,  16. 
of  Finished  Product,  73-76, 


206  Index 

Valuation — (Continued) 

of  Good- Will,  108-111. 

of  Machinery,  92-95. 

of  Merchandise,  62-70. 

of  Patterns,  101-105. 

of  Raw  Material,  83,  84. 

of  Real  Estate,  87,  88. 

of  Trade-Marks,  105,  106. 
Variations  in  Assets  and  Liabilities,  186-188,  191-195. 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 

Los  Angeles 
This  book  is  DUE  on  the  last  date  stamped  below. 


Form  L9-32tn-8,'57(.C8680s4)444 


UNIVfcKSlTY  of  CAL1FOKNIA 
library         AT 

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Uni^rsity  of 

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A     000186162     4 


